Financial Meltdowns Pressuring Real Estate Funds
Financial Meltdown Pressuring Real Estate Funds
New Strategies for Coping Include: Cancelling Cash Distributions, Selling Assets, Avoiding Risk
The October destruction that took place in the stock and credit markets has hit real estate investment funds of every portfolio makeup hard. Whether they hold properties, REITs or mortgages, funds have seen investors flee and assets drop precipitously in value.
In response, the funds have shored up their cash by selling assets, withholding dividends and readjusting their holdings to conserve value and avoid risk. As a result, success by the funds in the past quarter isn’t being measured in profits, but rather in limiting losses and avoiding foreclosure in some cases.
BlackRock, one of the biggest names in real estate funds, this week reported that the broadly adverse global capital markets hurt market values in all asset classes during the quarter. Assets under management ended the quarter at $1.26 trillion, down 12% since June 30, 2008 and 3% since Sept. 30, 2007.
Net losses for the quarter included $13.4 million in losses from real estate products compared to net gains a year ago of $26.9 million.
“I think it’s fair to say there is not one product in alternatives that has done well,” Laurence D. Fink, chairman and CEO of BlackRock, said in an investor conference call this week discussing third quarter results. “Hedge funds, private equity, real estate all were under extreme pressure.”
“I don’t think any of them expected to have these types of setbacks in terms of declines in [net asset value], but I think more certainly no one had expected to see such illiquidity,” Fink said. “So, I think one of the lessons to be learned will be a greater appreciation for liquid assets, and I do believe a lesson to be learned will be clients are going to have a more conservative portfolio.”
Absent a significant turnaround, Fink said. “Clients will need to reevaluate their assets and liabilities, reconsider allocation and diversification policies, and develop new investment strategies for the future.”
Even smaller funds, such as RMR Funds in Newton, MA, which has historically paid monthly distributions, is suspending distributions to shareholders until further notice. That includes its RMR Real Estate Fund, RMR Hospitality and Real Estate Fund and RMR F.I.R.E. Fund that invest primarily in common and preferred securities.
“In order to meet the asset coverage ratios which are pre-conditions to the payment of common share distributions, the funds may need to reduce their leverage by selling investment securities and redeeming preferred shares,” the company said in a statement to investors. “In an effort to avoid selling securities at distressed prices immediately and to preserve their ability to meet long term investment objectives, each fund is suspending its distributions to common shareholders to allow for a more orderly repositioning of each fund’s investment portfolio.”
NNN 2003 Value Fund LLC, managed by Grubb & Ellis Realty Investors LLC, also is suspending distributions effective Nov. 1, and putting most of its assets up for sale.
The company’s cash balances have decreased significantly this year due to operating losses, debt service requirements and distributions to unit holders.
As of Oct. 8, the fund had unrestricted cash balance of just $1.7 million, Kent W. Peters, CEO of the fund wrote to investors this month. Suspending distributions will enable it to reduce its expenditures by $290,000 per month. Those funds will be applied towards future tenanting costs to lease spaces in its properties.
The fund is trying to sell several assets yet this year and said it will evaluate the sale of its remaining assets.
Up for sale are:
901 Civic in Santa Ana, CA; 99,000 square feet. The property is currently 74% but the fund has a letter of intent to lease approximately 19,000 square feet of the building for five years.
Executive Center I in Dallas, TX; 205,000 square feet. The mortgage loan balance on the property of approximately $5 million became due Oct. 1, but was extended for one year to give it time to sell the property.
Four Resource Square in Charlotte, NC; 152,000 square feet.
Tiffany Square in Colorado Springs, CO; 184,000 square feet. The property has significant refinance exposure as the mortgage loan is due in February 2009. It is marketing the property for sale in order to avoid refinancing.
The Sevens Building in St. Louis, MO; 197,000 square feet. It is marketing the property in order to take advantage of a recent short-term lease signed with the largest tenant in the building and the favorable, assumable financing terms under the present mortgage loan.
Chase Tower in Austin, TX; 389,000 square feet. It is anticipated that the property will be marketed for sale some time in the first half of 2009.
Executive Center II & III - Dallas, TX; 381,000 square feet. The current mortgage loan with LaSalle Bank matures in December 2008; however, two one-year renewal options provide flexibility to market the property.
California Mortgage and Realty Inc. in San Francisco, which manages CMR Mortgage Fund II, has been trying to shift its holdings from primarily mortgages to properties. David Choo, president of the management firm, told investors this has been the toughest year it has ever experienced.
“Our assets, which are primarily mortgage loans and real estate properties we have acquired through foreclosure, are generally illiquid investments that have become even more illiquid during the past year,” Choo wrote to investors this month. “The fund has not been granting redemptions this year and thus ironically, there was no ‘run on our bank.’”
“The fund is not highly leveraged, although it is in many junior positions, and it continues to face challenges of meeting senior debt service requirements,” Choo continued. “These have been and still remain as serious ongoing challenges in an increasingly inactive and illiquid market. We continue to work through the borrowers’ delinquencies and foreclosures and bankruptcies. We continue this uncomfortable journey from being a mortgage investment fund that collected monthly interest payments and sent out monthly distributions to investors to a fund that is becoming an owner of real estate which needs to be managed, marketed and sold or held for the longer term.”
“The fund has managed to meet enough of its debt service requirements to avoid being foreclosed upon by senior lenders other than the few cases where the secondary collateral had insufficient equity value to justify additional investment on our part,” Choo wrote. “By not having had to sell properties at large discounts and not getting foreclosed out in large amounts, we have not to date suffered large losses as a result of losing collateral. We have also worked hard to meet the other operating expenses of the fund to enable our accountants, auditors, attorneys and other service providers to continue to work with us during these difficult times. And we have managed thus far to avoid having to ask our investors to help us by providing additional capital to allow us to better protect the existing capital that you and others already invested.”
In September, CMR Mortgage Fund II:
Acquired two properties: 7,100 acres in Lassen County, CA, intended for ski resort development, and 900 acres of residential development land in Casa Grande, Arizona.
Sold no properties.
Received offers on 28 acres of residential development land in Victorville, CA. Entered into contract to sell an apartment building in Concord, CA. We also entered into contract to sell an apartment complex in Fresno, CA, but that subsequently fell out of escrow.
Refinanced an office/warehouse facility in South San Francisco to raise $1.5 million in cash for immediate needs of the funds. Where it could not sell a particular property immediately, it, for the first time, borrowed against it to help meet monthly cash needs.
Not All Doom and Gloom
Despite the sea of troubles, fund managers were not signaling complete gloom and doom for real estate.
Philip Blumberg, chairman and CEO of Blumberg Capital Partners in Coral Gables, FL, said his firm has just completed a two-year liquidation of its funds real estate holdings and bought out most of its investment partners.
In anticipation of the price declines, Blumberg said, the firm is now exploring investment opportunities in commercial real estate, distressed debt and European REITs.
Laurence Fink, chairman and CEO of BlackRock, said he is also still a believer in real estate.
“I’m actually very bullish on real estate strategies as I believe in some of the real estate platforms, especially multifamily will be a product that we’ll be able to provide coupon and some price appreciation albeit, its going to be much lower than historical returns for this product areas. But I do believe real estate will provide a very safe platform for a lot of investors,” Fink said
