Distressed real estate IPOs carry big timing risk

NEW YORK (Reuters) - Three companies backed by major investment firms plan initial public offerings this week to take advantage of distressed commercial real estate, but they face stiff competition and major risks if the market takes a long time to recover.

Apollo Commercial Real Estate Finance ARI.N, backed by Leon Black's private equity firm, Colony Financial Inc CLNY.N, and AllianceBernstein's AB.N Foursquare Capital Corp FSQR.N are collectively looking to raise $1.4 billion in IPOs set to price and debut this week.

The dislocation in the real estate and commercial mortgage backed securities (CMBS) markets has prompted several top investment firms this year to create REITS that will buy up, manage and originate commercial real estate loans.

But the funds face the risk that the space is getting increasingly crowded with many investors, including hedge funds, private equity firms and other asset managers, starting funds for distressed real estate investment.

That may mean the easy money has already been made and those arriving now will have to settle for lower potential gains.

They also must contend with a tentative economic recovery that could turn into a double-dip recession with a further threat to commercial property prices.

“The hope of a resolution from all the government stimulus programs has already shrunk the discounts on these assets,” said Merrill Ross, an analyst with Arlington, Virginia-based broker-dealer BGB Securities.

“It could be too soon, it could be too late,” she said of the ideal timing to snap up the discounted assets.

The three deals on deck are the latest in a slew of IPOs -- so far in 2009, six IPOs by mortgage REITs have raised $1.96 billion, according to Thomson Reuters data.

“All three of these guys are going to fish among CMBS investors, hedge funds that need to liquidate ... and other distressed private investors,” said Jay Leupp, a portfolio manager of the Grubb & Ellis AGA Mutual Funds. “And the fishing is good, but the competition is emerging quickly.”

Making matters more complex, Ross said, commercial real estate varies tremendously from one market to the next, so it can be a crap shoot selecting what to buy.

For example, if the economy recovers without growth in jobs then office demand won’t come back quickly, and if consumers continue to increase their savings rates then shopping malls may not be a good bet.

The U.S. commercial real estate market has been reeling ever since a prime source of financing, the CMBS market, virtually closed and banks shut off their lending spigots in the past year.

When it filed in July for its IPO, Apollo Commercial Real Estate said, “markets are likely to face a void of several hundred billion dollars over this period that must be filled by new mortgage lenders.”

REITs are a tax structure that exempts companies earning most of their revenue from either rent or mortgages from paying taxes on their taxable income if the company distributes 90 percent of that to shareholders.

Some of the companies are relying on government programs to support bad assets in the banking system.

For example, Foursquare was created to buy so-called “toxic assets” under the U.S. Treasury’s public-private investment program, or PPIP, to help banks clean up their balance sheets.


With these IPOs essentially raising “blind pools” of cash until they buy assets, investors rely on management’s reputation in deciding whether to buy in.

Some of the IPOs have been snapped up: Barry Sternlicht's Starwood Property Trust Inc STWD.N scored the largest IPO of the year, at $951.5 million, after upsizing the deal twice, partly because of Sternlicht's reputation, BGB's Ross said.

But others have struggled because they were not seen as having hired the best talent, she said.

“There are a lot of them coming at once, so there’s a lot of competition for these managers to distinguish themselves,” said Mary Ann Deignan, head of equity capital markets for the Americas at UBS Investment Bank.

Crexus Investment Corp CXS.N, managed by a unit of Annaly Capital NLY.N, shrank its IPO by 60 percent the morning before pricing last week. In June, Invesco Mortgage Capital IVR.N-- owned by Invesco IVZ.N -- slashed the size of its IPO by more than half, settling for $170 million.

And more competition is on the way, with other REITs in the IPO pipeline, including a pair to be managed respectively by units of Angelo Gordon & Co and Brookfield Asset Management Corp. BAMa.TO

Existing REITs have raised billions in follow on share issues this year, giving them ammunition to take part in the distressed commercial real estate market too.

“Capital is returning to the real estate capital markets and this is a sign of that, and that means prices may not stay at distressed levels very long,” Leupp said.

Reporting by Phil Wahba and Nick Zieminski; Editing by Richard Chang