Capital Freeze Beginning To Thaw

Real-estate funds saddled with tens of billions of dollars of boom-time properties are beginning to get some relief from Wall Street firms and other investors hoping to capitalize on their need for cash.

Opportunistic investors are buying stakes in troubled funds at steep discounts or lending the funds money in deals that give them a steady return and potentially a share in the profit if real-estate markets rebound. At the same time, some funds are succeeding in persuading existing investors to cough up more capital, although this typically is an uphill stream

In the latest deal, Clairvue Capital Partners, founded early this year with $250 million from Goldman Sachs Group Inc.’s private-equity group, is set to announce Wednesday that it made a $60 million credit line to a $450 million real-estate fund closed in 2006 by Normandy Real Estate Partners. Earlier this year, a $1.2 billion fund run by CB Richard Ellis affiliate CB Richard Ellis Investors got a cash infusion, totaling $55 million, from J.P. Morgan Chase & Co. to recapitalize a $500 million portfolio of office buildings, according to people familiar with the matter.

These deals are the latest sign the capital freeze plaguing the commercial-real-estate industry since the global financial downturn is beginning to thaw. For two years, property owners have refrained from selling to avoid realizing losses. But in recent weeks, some banks have also shown an increasing willingness to sell distressed assets at discounted prices because their balance sheets have stabilized and values have bounced back from their lows.

The pickup in deal making also is a reflection of widespread uncertainty over the direction of the economy. Some owners are eager to recapitalize now for fear that a double-dip recession could send values plummeting again.

Real-estate funds are a particularly needy bunch. By some estimates, about 80%—or $335 billion—of the $420 billion amassed in the U.S. by real-estate funds since 1999 was raised from 2005 to 2008, the height of the market. And the money was spent quickly spent.

Goldman-backed fund is making credit available to Normandy Real Estate, which owns Boston’s Hotel Indigo.

Now, amid depressed property values and maturing loans, a total of 40 private-equity real-estate funds have gone back to their investors for additional capital since last year, according to Townsend Group, which invests on behalf of institutional clients. But only a handful, including funds run by Deutsche Bank AG and Stockbridge Real Estate Funds—have been successful, as existing fund investors like pension funds and college endowments worry about throwing good money after bad.

It took more than a year for the $1.6 billion fund run by Deutsche Bank’s real-estate-investment unit, named RREEF, to line up $100 million of additional capital from its investors, according to people familiar with the matter.

A disclosure made by Pennsylvania’s Public School Employees’ Retirement System provides a window into the desperate needs for cash by some fund managers and the kind of hefty rates that usually come with the extra funds.

According to a presentation made to the board of the retirement system on Aug. 11, a $1 billion fund operated by Stockbridge Real Estate Funds “is facing significant loan maturity and fund-level liquidity issues” and likely “would be forced to abandon or liquidate many of its assets” absent the injection of new capital.

The staff of the retirement system, which had an original commitment of $162.5 million to the fund, recommended it contribute another $20.3 million as part of a $125 million credit line to the fund. The annual interest rate on the new money: 25%.

But most real-estate funds haven’t been able to raise additional capital from investors, nor do they have any remaining promises that investors made to provide additional money in the future, or “uncalled commitments.” That gives Wall Street firms leverage to be opportunistic.

Without the ability to tap existing investors, “they are stuck,” says Jeffrey Giller, managing partner and chief investment officer at Clairvue Capital Partners.

Some investors are simply buying stakes in funds from institutions that have resigned themselves to cashing out at a discounted price.

Others are making deals with the funds directly. In the J.P. Morgan recapitalization of the CB Richard Ellis portfolio, the bank injected $55 million in capital and, in exchange, got preferred equity in six buildings in the portfolio.

A Normandy Real Estate Partners fund owns two Summer Street office buildings in Boston, above.

“A lot of capital is lining up to take advantage of the opportunity” to recapitalize property funds, says Anthony Frammartino, a principal of Townsend, of Cleveland.

The Clairvue fund backed by Goldman was set up in April to provide capital to help restructure real-estate funds. The loan to Normandy is its first deal.

The Normandy fund, which has holdings that include the Indigo Hotel and two Summer Street office buildings in Boston, purchased most of its properties near the peak of the market and will use the money primarily to buy back its existing debt at discounts.

Jeff Cronning, managing principal of Normandy, predicted in a statement that the increase in the fund’s return from the new capital will be greater than the cost of the capital. (credit wsj, L.Wei)

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