Sizing up the big players making distressed buys

Ofer Yardeni

At times, this city can seem like an ocean of distress without a drop to drink. Half-built or unsold condos abound. Office buildings dot marginal neighborhoods offering low rents to stay full. Loans secured by real estate are in trouble all over. Yet all this distressed commercial inventory can be elusive, kept off-limits by banks waiting for a full recovery and perhaps mindful that in the last downturn, in the early 1990s, they may have let go of valuable real estate too soon. Nonetheless, some are figuring out how to wrest control of these troubled properties, and this month The Real Deal compiled a scorecard of the big private equity funds clearly leading the way.

“You’re seeing them just take over the real estate market,” said Jeffrey Lenobel, a partner at Schulte Roth & Zabel, where he heads the real estate group. That newfound aggressiveness is being stoked by huge piles of capital, which many are raising into funds or pools of investor money, or redeploying from previous funds into distressed assets.

While precise numbers aren’t available — certain Securities and Exchange Commission rules prohibit investors from talking about funds while they’re raising them, though private equity firms are notoriously secretive anyway — there could be some $25 billion with New York-based firms ready to be funneled into struggling properties or mortgage notes in the city, analysts say.

In 2009, distressed sales accounted for 8.4 percent of all sales, according to Real Capital Analytics, a real-estate research group, versus 11.3 percent of sales through early November of this year.

Goliaths like the Blackstone Group, BlackRock, Fortress Investment Group and Starwood Capital Group have plunged headlong into distressed real estate, according to brokers, but so, too, have smaller players like Square Mile Capital Management, Beck Street Capital and Murray Hill Properties.

Here are some major names in the distress market poised to break away from the pack.

Savanna Partners

This 18-year-old fund seems to be at the vanguard. Out of a $200 million fund earmarked for distressed opportunities, more than $100 million has been spent this year, at addresses like 386 Park Avenue South, where Savanna paid $42 million for a note held by Monday Properties.

Another example is 104 West 40th Street, a 210,000-square-foot office building that’s 60 percent vacant. Savanna paid $62 million for the building, according to reports, including shelling out $46 million for a soured loan of $55 million. In October, it also purchased 5 Hanover Square from developer Kent Swig (see profile of Swig on page 44) for an unknown amount, though the face value of the mortgage held by Capital One Bank was $60 million.

“It’s good to be getting great New York City office buildings at a terrific basis,” Nicholas Bienstock, a managing partner, told The Real Deal, though he would not comment on reports that he’s busy raising a second fund now.

HFZ Capital Group

While some firms may be waiting on the sidelines, it’s showtime for HFZ. “Our group is the exception to the rule,” said Ilan Rubinstein, a principal with the firm, which has spent $200 million in the past 12 months on distressed assets, although not from a fund per se. The bulk of the capital is distributed on behalf of foreign investors “who understand that Manhattan is the center of the world,” Rubenstein explained.

In terms of opportunities, HFZ favors unfinished condos, which is why it has been drawn to sites like 14-20 West 40th Street, where Ascent Real Estate Advisors had planned a 31-story condo. HFZ picked up the defaulted mortgage for $41 million and the deed there for $5 million, according to news reports.

Also this year, HFZ bought the note to the condo shell at 303 East 51st Street, where a fatal crane collapse occurred in 2008, for $40 million from Arbor Realty Trust, after original developer James Kennelly defaulted.

Another half-dozen projects are close to being done deals, too, Rubinstein added, without elaborating.

Stonehenge Partners

Longtime real estate player Stonehenge, which owns or manages 19 properties with 2,700 units, knows what it likes: elevator rentals in prime Manhattan neighborhoods that could benefit from upgrades. And once those high-rises are filled with tenants, analysts say, principal Ofer Yardeni offers homey personal touches, like in-house newsletters.

Yet as Yardeni seeks to raise a $1 billion fund (his seventh, according to reports), he also looks to be divesting himself of certain assets, like 401 West 56th Street, which this fall sold for about $40 million, according to reports. In 1995, it cost $5 million.

But the firm hasn’t been sitting on its hands. Tapping a previous $500 million fund, Stonehenge bought a 178-unit building in Greenwich Village from St. Vincent’s Hospital, which shuttered this year, for $67 million.

Stonehenge did not return calls, but other brokers were effusive in praise. Everything that Yardeni “touches, he turns to gold,” said Adelaide Polsinelli, a broker with Marcus and Millichap. “He’s one of the smartest guys out there.”

Square Mile Capital Management

Specifically focused on undervalued real estate, or that which is “overlooked, complex or mispriced,” according to its website, Square Mile closed an $806 million fund in February 2009, according to John Linger, a senior principal.

An early target appears to be 837 Washington Street, in the Meatpacking District, where a new office building will rise in a joint effort with Taconic Investment Partners. In a sense, the site has been in Square Mile’s hands for a few years: In 2008, it was purchased for $45 million by event planner Robert Isabell, who borrowed $48 million from Square Mile and Taconic to pay for its development. Though the lenders sought foreclosure after Isabell died in 2009, a deal was eventually worked out, outside of court.

Another property where Square Mile is a lender and is doubling down on its investment instead of selling is the condo at 515 East 72nd Street, formerly known as Miraval Living, where the firm has tried to reboot sales with a new marketing team.

“I think they are very smart; they know how to find and source opportunities,” said Polsinelli of Marcus and Millichap. “They used to say it was location, location, location, but it’s also timing, timing, timing, and they’re moving at the bottom of the cycle.”

The Praedium Group

Interested in underperforming assets across the country, Praedium seems to have plenty of money to play with. Its $900 million Fund VII is only half spent since closing.

Target buildings are between $5 million and $75 million, according to the company, and in New York, Praedium is eyeing offices, stores and apartment buildings, said president Russ Appel. And even though supply seems limited, Appel reminds buyers that in the 1990s, it took several years for sales to start in earnest, too. “With the process of the liquidation, the private sector takes a lot longer than government,” he said, adding that 2011 should be bountiful: “It’s coming.”

In the meantime, the company is in sales mode, unloading 13 buildings in Jamaica, Queens, for about $9 million in October. Perhaps the move was to help service a troubled $192 million loan that it has in a partnership with the Pinnacle Group for 36 Upper West Side apartment buildings slated for conversions to condos.

Beck Street Capital

The $200 million the firm has raised will likely be spent in the next year on four deals, with about $50 million per deal, said Chris Gratto, a vice president who handles acquisitions. Some of that will probably be invested in New York, he said, though the city does not offer the 12 percent cap rates the firm prefers, but instead half that, at best.

And the kinds of discounts that buyers of notes like — 30 to 40 percent — are not really available here, Gratto added. “The owners of many properties here don’t feel compelled to sell,” he says. “They would rather wait for the market to rebound.”

Beck Street is instead playing to its strength, brokers said, which is realizing the untapped value of retail spaces, like along Bleecker Street in the West Village, where it repositioned dowdy storefronts and installed some high-end fashion retailers. Examples include a freshening at No. 367, which has a new Burberry store, and No. 387, which now has Mulberry, a handbag store.

Centerbridge Partners

With at least $1 billion in funds — and raising more, according to news reports — Centerbridge is an active player in the distressed market.

In May, Centerbridge, backed by Paulson & Co. and the Blackstone Group, won a bid to buy the assets of the bankrupt Extended Stay hotel chain, beating out Starwood Capital Group. (Centerbridge’s winning offer was about $4 billion.) Centerbridge, however, failed in its bid to increase its stake in General Growth Properties, the bankrupt owner of South Street Seaport, analysts say.

But the firm, which was founded by Blackstone executives, may have better luck bidding on iStar, the troubled lender of many high-profile New York condo projects.

The firm did not return calls for comment, but Ben Thypin, an analyst with Real Capital Analytics, said these deals are typical of the firm’s approach. “They are playing a slightly different game, targeting companies as opposed to buildings,” he said. “They are also representative of how hard the distress market is to invest in en masse.”

Fortress Investment Group

This titan closed on a $2.4 billion fund in July, according to a source at the company who declined to be identified, exceeding its target of $2 billion. About a third of that money comes from individuals, the source said, with 27 percent from institutions and 23 percent from public pensions.

Some but not all of it will be spent on “undervalued” real estate, and possibly deals in New York, like the firm’s 2009 purchase of the debt on Sheffield57, originally developed by a team that included Kent Swig, for less than 40 cents on the dollar. Although Fortress will have to share its profits with Swig under the deal, that will happen only after Fortress and its investors achieve certain returns first.

All told, with so much capital at its disposal for future deals, Fortress seems poised to break out big. Lenobel, of Schulte Roth & Zabel, said that he can’t comment on firms he works with, which is the case with Fortress. But in general, he sees unexplored opportunities for firms in note sales. “I still think there will be more volume in secondary debt acquisitions, like mezzanine and complex structured mortgage loans,” he said.

Marathon Asset Management

More of a lender than an active buyer, Marathon has nonetheless tiptoed into the local market so far, investing in a 386-room Doubletree hotel by JFK Airport by originating a $24 million mortgage to help pay off the existing note.

At the time, Scott Schwartz, the 12-year-old firm’s co-head of real estate, said the advantage Marathon offered in the time-sensitive deal was that it helped the borrower pay off his loan “in less than a month.”

However, another recent distressed deal included a $28 million loan to a hospitality firm that owned two troubled hotels in Basking Ridge and Warren, both in New Jersey. No one at the firm returned calls for comment, but Thypin, of Real Capital, said to expect more from Marathon soon. “It’s just a question of where they are putting it and how they are deploying it,” he predicts.

Murray Hill Properties

Next year, after seasoned player Murray Hill closes its fifth fund, which should total between $500 million and $750 million, according to a source at the company who declined to be identified, it will start to invest broadly in New York.

Those funds could flow either to struggling landlords, to help them recapitalize their loans, or to assets directly, like office buildings, for an ownership stake, though the firm isn’t interested in buying apartments, the source said. Also possible are purchases of senior debt, though those deals are harder to come by today because mortgage note prices have risen and “are back in the money,” the source said.

But the 39-year-old firm isn’t sitting around idly. Over the summer, Murray Hill acquired 509 Fifth Avenue, a 60,000-square-foot office building, from embattled developer Joseph Moinian. The firm plans on repositioning each floor of the 12-story building as an office condominium, the source said, as they are rare on major avenues.

Separately, the firm has been busy on the sales side, too. This month, it should close on the sale of 1412 Broadway to Virginia’s Harbor Group International. Harbor paid $150 million for the 400,000-square-foot office building.