Real Estate 'Opportunity' Funds Seeking Out Bargains

By JESUS SANCHEZ

Nov. 6, 2001 12 AM PT

TIMES STAFF WRITER

With a recession on the horizon and property markets weakening, it would seem that most real estate investors would be running for cover. Not Douglas Shorenstein.

Shorenstein and other so-called opportunistic U.S. real estate investors are raising cash and mobilizing teams of savvy analysts and negotiators to take advantage of the deals that are certain to pop up as the economy weakens.

More than 20 major “opportunity” funds seeking to raise at least $6.5 billion have been formed in the last year to snap up under-performing or failing properties, according to consulting firm Ernst & Young.

Opportunity funds buy distressed, deeply discounted properties and sell them when values rebound. So-called vulture funds take on even greater risk in the hope of higher returns.

The deals won’t be as plentiful or as rich as those in the early 1990s, when newly formed opportunity and vulture funds feasted on a seemingly endless supply of foreclosed and government-owned properties and loans. But the months and years ahead promise to offer prime buying conditions for investors who can stomach a bit more risk.

“Every time we are in a down cycle, everybody wants to jump out the window,” said Shorenstein, whose San Francisco-based real estate investment fund recently raised $600 million. But, “in this market today we are active buyers. We have several deals on our plate.”

The booming U.S. real estate markets of recent years forced opportunity funds to accept lower returns or scour Japan, Latin America and Eastern Europe for high-return deals. But many of the funds have shifted their attention back to the U.S. as signs of economic problems have mounted and once-confident landlords grow concerned about rising vacancies and falling rents.

“They are all out there raising capital,” said Sandy Presant, national director of opportunity fund services at Ernst & Young. “There is a whole lot of money lined up waiting for places to invest in the U.S.”

Fund managers are already knocking on the doors of corporations--particularly those in the struggling technology sector--to offer them badly needed cash in return for company real estate. Some buyers will be looking for unique deals that would require finding new uses for surplus movie theaters, telecommunication switching stations, old shopping malls and newly minted hotels.

“People will need to cash in on their real estate to support their business in these tough times,” Presant said.

During the recession and real estate bust of a decade ago, opportunity and vulture funds filled the void left behind by shellshocked bankers, insurance companies and pension plans. The funds promised and often delivered returns in excess of 20% annually to investors who were banking on an eventual economic recovery.

The funds overcame the sneers of real estate veterans--who often regarded the newcomers as brazen predators--to become part of the real estate and financial establishment. Pension plans, college endowments and wealthy families and individuals have poured billions of dollars into the more than 200 real estate opportunity funds now in existence. Goldman Sachs’ Whitehall Street Real Estate Fund alone has raised about $11 billion since its inception in 1991.

“These are the smartest minds in real estate finance and they have built extensive infrastructure to track opportunities worldwide,” said Jack Barthell, a partner in PricewaterhouseCoopers’ real estate capital markets group.

Barthell and other industry observers say opportunity funds will have to work harder this time around to find property and suitable deals that deliver the high returns investors came to expect a decade ago.

“A lot of money is being raised, but there is not a lot of desperation [among owners] out there to sell,” said Los Angeles real estate investment manager Wayne M. Brandt at Menlo Equities.

Unlike in the early 1990s, few cities have been overbuilt and there is no huge inventory of government and bank-owned real estate that needs to be auctioned off at fire-sale prices. In addition, financing is plentiful and cheap, allowing many landlords to refinance and hold on to their properties.

“You are not seeing huge portfolios trading like a few years ago,” said Drew Planting, who heads Snyder Partners, a newly formed $50-million fund affiliated with veteran Los Angeles developer Jerry Snyder. “We knew going into this that it was going to take time, diligence and a real effort to pursue these deals.”

There will also be fewer deals that require opportunity funds to simply hold on to an office building or industrial park for a few years before selling it for a profit. Many more deals will require intensive real estate management and development to squeeze out the profits the funds have promised.

“They will have to understand the special nature of the real estate and the businesses that operate in it,” said Barthell at PricewaterhouseCoopers.

But it’s clear that the opportunity fund managers will have more to choose from in the coming months. Many landlords who once were expecting a quick economic rebound are coming under greater pressure to lower their expectations and asking prices as vacancy rates rise and rents remain flat or fall.

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Looking for Bargains

Real estate opportunity funds are busy raising cash to take advantage of weakening property markets. Some of the new funds include:

Fund: Shorenstein Realty Investors Six

Size: $600 million

Focus: High-rise, urban office properties

Sponsor: Shorenstein Co., San Francisco

Fund: Page Mill Properties

Size: $350 million to $500 million

Focus: High-tech properties

Sponsor: Divco West Properties, San Jose

Fund: Snyder Partners