Nothing could be sweeter to a wealth manager's ears than the words "dislocated markets," and no sector has suffered more dislocation in recent years than real estate.
Developers, syndicators and other real estate mavens who made killings buying foreclosed commercial and residential properties from developers and banks in the 1990s are again on the prowl, soliciting institutional and wealthy individual investors to participate in still-distressed real estate markets that began unwinding three years ago.
Investors can participate in numerous ways-by investing in private partnerships and funds that buy loans, by investing in mortgage-backed securities or by investing in property that comes directly from delinquent borrowers or banks or from the Federal Deposit Insurance Corp.
Since the start of 2009, 71 funds have raised $42.5 billion from institutional investors to buy distressed real estate or real estate debt, according to Preqin, a London-based alternative investments research firm, and several feed funders are now available for wealthy individual investors and family offices to participate in these portfolios.
Starwood Capital Group, whose founder Barry Sternlicht built a hotel empire on the back of the 1990s real estate recession, persuaded investors to put about $950 million into an initial public offering for a blind real estate pool last year, and this year raised $2.8 billion from high-net-worth and institutional investors in two new "opportunistic" funds. Brookfield Properties and its majority owner, Brookfield Asset Management, in July announced plans to amass $4 billion to buy distressed real estate firms and portfolios.
Individual investors, not surprisingly, are clamoring for action. They've bid up publicly traded real estate investment trusts to become the year's hottest stock fund sector, and wealthier investors and their advisors have followed the smart institutional money into small private pools aimed at distressed real estate.
They're also pouring billions of dollars into wrap vehicles. Thirty-three real estate funds of funds have raised $6.1 billion since 2008, according to Preqin; that includes $900 million raised through six funds in the first nine months of this year.
With so many vehicles available, dare advisors resist operators' whisperings of 20% returns or more in the distressed market, or the pleas of yield-hungry clients eager to shop in the bargain basements of commercial and residential real estate?
It's irresponsible to ignore such opportunities, many advisors say. But then they must also quickly learn that real estate demands more homework about the quality of managers and the liquidity needs of clients than perhaps any other asset class.
"There has been dislocation on a massive scale, and significant disruptions in any market are going to lead to capital being raised and opportunities pursued," says Benjamin Dickey, the director of wealth management services at Reinhart Partners Inc., a Milwaukee-based RIA with $3.2 billion of assets under management for institutions and wealthy individuals. "But that doesn't make this appropriate for everyone."
Investors in distressed real estate must be comfortable tying up what can be a significant percentage of their taxable investment assets in illiquid vehicles, he says, and have the patience to wait at least five years-and perhaps as long as ten-for the investment sponsor to make good on the returns they seek.