Investors ready to snap up distressed assets, hoping to cash in later

Investors ready to snap up distressed assets, hoping to cash in later

12:24 AM CDT on Sunday, September 28, 2008

By BRENDAN M. CASE and CHERYL HALL / The Dallas Morning News

The worst financial crisis since the Great Depression? For some deep-pocketed Dallas investors, that's like ringing the dinner bell.

Two decades after a savings and loan debacle flattened some North Texas fortunes – and fattened others – fresh money is massing to buy distressed loans and properties the government cannot or will not buy this time around.

Call them the "New Vultures" (they prefer the term "opportunity funds"). These investors aim to snap up teetering assets such as real estate and mortgage-backed securities on the cheap, then cash in when prices recover.

"It's a lot of risk-taking and a lot of work," said Dallas real estate developer Craig Hall, who's teaming up with commercial real estate broker Herbert Weitzman to buy distressed real estate.

"We're going to see one of the greatest transfers of wealth in our lifetime."

The wealth transfer he has in mind is not necessarily from taxpayers to rich investors, and no one's celebrating the wave of foreclosures at the root of the current crisis.

The transfer Mr. Hall has in mind is from bloodied financial institutions and desperate property owners to people (like him) who are ready to plunk down some cash.

Waiting for a bottom

Many investors are waiting to see a bottom before plunging in.

Housing prices still have a ways to fall in many U.S. markets, analysts say. Dropping home prices fuel foreclosures, which are still on the increase. That will continue to slam the value of the mortgage-backed securities now taking down banks and jamming the financial system.

Would-be buyers are also following the fate of the proposed $700 billion federal bailout plan for clues about where asset prices are apt to settle.

"A large part of our banking community is probably sitting back and saying, 'Let's see what the government does,' " said Phil Dixon, president of Treadstone Partners LLC, a Dallas investment firm.

What's certain is that there's not enough federal largesse to buy up all the bad debt out there. So there will be opportunities for the private sector no matter what the government does.

The problems – or opportunities, depending on your perspective – are bound to extend well beyond the housing loans.

Investors like Mr. Hall and Mr. Weitzman see the fiasco as the first act in a tragedy apt to entangle credit cards, car loans, office buildings, undeveloped land and an assortment of loans backed by troubled collateral.

"Everything that's being talked about is related to subprime and mortgages, but there are a lot of commercial projects that in my mind are the 'subprime' of that industry," said North Texas developer Fehmi Karahan, who organized a fund this year to acquire distressed commercial real estate.

"You may see another wave of things that shouldn't have been built and are leveraged too thin hit the marketplace in the next two to three years," said Mr. Karahan, who developed the Shops at Legacy in Plano.

Some $300 billion or $400 billion in investment dollars could become available worldwide, said Mike Bryant, a Dallas-based executive with Capmark Financial Group Inc., a California real estate finance company.

"There's about 300 to 400 different funds being put together that are ranging in size from $25 million to $1.5 billion, and even up, who are going to get in there and bid on these assets," Mr. Bryant said.

Who's buying

Those eyeing distressed assets include wealthy individuals, pension funds, hedge funds, endowments – even Texas schoolteachers, acting through their retirement system.

One high-profile private equity firm, Dallas-based Lone Star Funds, has already gambled big on distressed mortgages.

Lone Star is headed by John Grayken, who worked with Fort Worth billionaire Robert Bass to snag distressed properties after the savings and loan bust of the 1980s.

In July, Lone Star agreed to shell out $1.5 billion and assume $4.4 billion in debt to buy a mortgage portfolio with a paper value of $9.3 billion. That works out to about 63 cents on the dollar.

The same month, the firm agreed to pay Merrill Lynch & Co. $6.7 billion for a $30.6 billion portfolio of mortgage-backed assets – or 22 cents on the dollar. Lone Star even got Merrill to help finance the deal.

Now others are on the prowl.

Mr. Hall, the Dallas developer, is mulling over distressed paper assets such as mortgages along with hard assets such as commercial real estate, residential lots and condominiums that might be purchased directly from distressed owners.

The big unknown is how to value such assets.

"If you have a subdivision with 300 lots and nobody's bought a house there in a year or two, what is that worth?" he mused.

But unlike the real estate flipping that helped fuel the housing bubble a few years ago, Mr. Hall said these new opportunities will require patience and staying power.

Waiting it out

Investors will need a good eye to spot investments with underlying value, as well as enough time and money to wait out the downturn.

"It's going to be six years, not a year or two," Mr. Hall said.

Since many mortgages have been rolled into complicated debt securities, another challenge is figuring out who can legally sell the houses.

Terry Buell, principal of SMI Mortgage Co. in Dallas, is working with an investor group hoping to get big discounts on foreclosed homes and nonperforming mortgages in housing bust areas such as California and Florida.

"We've had the money available for quite a while now," he said. "The problem has been in finding sellers that have the ability to actually sell a large pool of houses."

Even Texas teachers have been getting in on the action, said Dory Wiley, president and chief executive of Commerce Street Capital LLC, a Dallas-based investment bank.

Mr. Wiley also sits on the board of trustees of the Teacher Retirement System of Texas, a pension fund with more than $100 billion in assets.

Mr. Wiley got a call this year from Larry Fink, chairman and chief executive of BlackRock Inc., a New York money management company.

Would the Texas teachers' fund like to buy a chunk of a $22 billion mortgage portfolio that BlackRock was purchasing for $15 billion from Swiss bank UBS?

"We bought $250 million," said Mr. Wiley, referring to TRS' participation in the deal.

Now Commerce Street Capital itself is looking to lend to or invest in banks. The firm has a $500 million fund to pour into community banks and a $1 billion fund to buy up bank debt.

"We're going right into the epicenter of the problem," Mr. Wiley said. "I wake up at 3 a.m. I can't sleep. I'm so excited about the opportunities."

Lesson of the '80s

So how much do these investors stand to profit from buying distressed debt, homes and commercial real estate?

Many are eager to take advantage of what they think happened in Texas in the wake of the real estate bust and savings and loans crisis of the 1980s – instant riches from quick flips of raw land, apartment and office buildings bought from the government at fire-sale prices.

Vultures, take note: To some extent, those memories are wrong. In most cases, it took several years for Texas real estate to climb out of the morass. Investors who didn't have staying power lost their skivvies.

But there were also success stories. One example among many is the property that the Stonebridge Ranch community in McKinney sits on today, said real estate developer Henry Billingsley, who watched the unfolding transactions as a nearby landholder.

In the early 1980s, thousands of acres of raw land were purchased for $125 million. Infrastructure worth $175 million was added. The RTC took ownership and quickly offloaded it for $32 million to a large New York investment company, which sold it within a few years to another New York firm for $64 million.

"A $300 million property marked down to $32 million," Mr. Billingsley said.

"It's hard to make a mistake buying at 10 cents on the dollar," he said. "They must have thought they'd died and gone to heaven."

Staff writer Eric Torbenson contributed to this report.