Market frowns at glut of REIT vulture funds

Tom Barrack is considered one of the savviest commercial real estate investors of the last 20 years. But his bid to lure public investors to join with him fell far short this week.

Barrack, the 62-year-old founder of L.A.-based real estate and private-equity giant Colony Capital, wanted to raise $500 million via a new real estate investment trust that would buy troubled commercial property debt.

His Wall Street bankers could rustle up only half that sum from investors. The initial public stock offering of Colony Financial Inc. raised $250 million Wednesday by selling 12.5 million shares at $20 each, instead of the 25 million shares Barrack had wanted to issue.

The stock began trading Thursday in the red, closing at $19.50.


What went wrong? The deal tripped in large part because too many of Barrack’s rivals -- including Barry Sternlicht of Starwood Capital and Leon Black of Apollo Group Management -- have raised or are trying to raise money for the same kind of vulture funds. The market is becoming at least temporarily glutted.

Beyond that, many investors just don’t like the structure of the deals. Shareholders of these REITs will pony up hefty management and incentive fees -- out of trust assets -- to pay Barrack and the other fund managers, who will work under contract with the trusts to find and manage opportunities in distressed commercial mortgages.

But what the shareholders will reap is a big unknown. It will depend on the income generated by the loans and any capital gains the trusts earn by eventually selling the debt -- less any losses on troubled loans that go from bad to worse.

“There are going to be opportunities in commercial mortgages, and these guys are going to be able to take advantage of that,” said Mike Kirby, a principal at real estate securities research firm Green Street Advisors in Newport Beach. But he believes the structure of the trusts is “universally bad,” assuring a profit for the managers while potentially shortchanging investors.

Many investors buy REITs to earn a continuous stream of income, Kirby noted. Because vulture funds are by definition opportunistic, “the consistency [of income] definitely won’t be there” for shareholders, he said.

Kirby asserts that it’s smarter for investors who want to play for bargains in the depressed commercial real estate market to stick with conventional REITs such as Vornado Realty Trust and Simon Property Group, which own property rather than mortgages. Property REIT managers work directly for shareholders, as most corporate executives do, as opposed to the hired-gun management structure employed by the new vulture mortgage REITs.

An analyst at one brokerage that helped underwrite the Colony Financial deal said he had plenty of calls from interested investors but that many didn’t like the unavoidable “blind pool” aspect of the deal.

What’s more, he said, investors know that a key reason private equity shops are turning to the public market to raise funds is that many of their pension funds and other usual sources of money are tapped out. In other words, the public market is the fallback option, which also makes those investors suspicious.