IPO investors not sold on REITs that buy distressed mortgages

But fund managers still will take a close look

Sep 27, 2009 @ 12:01 am

By David Hoffman

Despite troubling signs that investors aren't sold on new real estate investment trusts that plan to purchase distressed-mortgage assets — in many cases with the help of government financing — mutual fund managers still intend to take a close look at them. Two such REITs that focus on -distressed-commercial-mortgage-backed securities — Apollo Commercial Real Estate Finance (ARI) and Colony Financial Inc. (CLNY) — last week were forced to delay by a day and cut in half the size of their initial public offerings because of a lack of demand. A third IPO, for Foursquare Capital Corp. (FSQR), a REIT focusing both on commercial- and residential- mortgaged-backed securities, was postponed. As of press time, no word had been given as to when that REIT might make it to market. Run and advised by a unit of AllianceBernstein LP, the Four-Square REIT plans to purchase a portion of its holdings through the legacy securities portion of the government's Public-Private Investment Program — the major initiative by the Department of the Treasury to help remove bad mortgaged-backed debt from bank balance sheets. The other REITs plan to tap government financing through the Federal Reserve's Term Asset Backed Securities Loan Facility. Despite their difficulties coming to market, other IPOs are planned, including one this week for Ladder Capital Realty Finance Inc. (LCG). That REIT is expected to focus on distressed-commercial-mortgage-backed securities. The time is right for such REITs, their managers say. “We have seen the obliteration of the entire mortgage business as we have known it for 30 years,” Jonathan Sobel, chief executive of Foursquare, said in a video presentation for potential investors. “What will result from this meltdown is a complete restructuring, a once-in-a-generation opportunity.” Mutual fund managers agree. New REITs focusing on distressed-mortgage-backed securities will give fund managers “an opportunity to get opportunistic,” said Joseph Betlej, head of the real estate securities team at Advantus Capital Management Inc. and manager of the Ivy Real Estate Securities Fund (IRSAX), which Advantus subadvises for Ivy Investment Management Co. REITs that focus on distressed-real-estate securities “are expected to pay nice, healthy divided yields, which fit nicely with our strategy,” said David Levy, a U.S. REIT analyst with Franklin Templeton Investments Inc. and co-manager of the Franklin Real Estate Securities Fund (FREEX). The dividend yields should be big.

“By and large, these REITs should provide double-digit yields,” said Sam Lieber, chief executive of Alpine Woods Capital Investors LLC and the lead manager of the Alpine Emerging Markets Real Estate Fund (AEMEX) and Alpine Cyclical Advantage Property Fund (EUEYX).

But there are risks.

The new REITs focusing on distressed-mortgage securities are essentially “blind pools” that must raise cash before buying any securities, said Scott Westphal, a managing director of the real estate securities investment management unit of Cornerstone Real Estate Advisers LLC.

The problem is that there is no evidence yet that they will be successful in scooping up distressed-mortgage-backed securities at a discount, said Mr. Westphal, manager of the Oppenheimer Real Estate Fund (OREAX), which is subadvised by Cornerstone for OppenheimerFunds Inc.

“We're in a wait-and-see mode in terms of whether they will be able to access distressed debt at yield levels that are attractive to investors,” he said.

There is some concern that while there still may be bargains in the distressed-mortgage-backed-securities market, they are becoming harder to find, said Steven Brown, a vice president and senior portfolio manager with American Century Investment Management Inc.

“In general, liquidity has improved and bid-ask spreads have tightened,” said Mr. Brown, manager of the American Century Real Estate Fund (AREEX).

Added Mr. Levy: “It's becoming increasingly difficult to find value.”

Such concerns are why Mr. Westphal said he doesn't plan on being a big buyer of the new mortgage-backed REITs.

“We think a few of the shops that have the infrastructure are going to do pretty well, but there will be a lot of people that are in over their heads,” he said.

Some financial advisers are even more leery.

REITs investing in distressed-mortgage securities may do well, conceded Lewis J. Altfest, president of Altfest Personal Wealth Management, which manages about $500 million in assets.

He doesn't see the party lasting long.

“The drop in the value of mortgages is only partly due to emergency circumstances,” he said. “The other part, in my opinion, is that there has been a drop to more realistic levels of valuations for real estate.”


It definitely seems there is greater value to be had elsewhere, said Mark Balasa, a financial adviser and co-president of Balasa Dinverno & Foltz LLC, which manages $1.5 billion in assets.

The National Association of Real Estate Investment Trusts' FTSE NAREIT All REIT Index was up 15.89% year-to-date at of last Thursday, while the Standard & Poor's 500 stock index which was up 18.52%.

And Mr. Balasa said he's concerned that the real estate sector may yet face challenges that could make investing in distressed mortgages a little too risky.

Mr. Brown, however, said he believes that most, if not all, of the bad news concerning real estate has come out, and that REITs should continue to perform well.

“The REITs are up about 20% year-to-date,” he said. “That's a reflection that the global economy is improving and we are still in a low-interest environment.”

Such an environment is favorable to REITs, Mr. Brown said.

It is unlikely that they will continue to generate such strong returns, but REIT returns should still be respectable, he said.

Alpine's Mr. Lieber agrees.

“We're looking at a period where there should be long-term growth,” he said.

E-mail David Hoffman at dhoffman@investmentnews.com.


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