When distressed assets do become available, these managers say, yield-hungry neophytes overpay for them in bidding wars. Sternlicht, for example, says he bid 57 cents on the dollar for a pool of assets being offered by the FDIC that turned out to be 42% below the winning bid.
Any strong properties or loans that are up for sale are being seized by publicly traded REITs, which have easily been outbidding private competitors, LeFrak said. Part of the public funds' strength is that they've been able to raise capital cheaply from investors who have become satisfied with dividends of 3%.
With so much money chasing so little supply, funds are returning money. At least 19 distressed funds have returned more than $6 billion of total equity to their limited partners since 2008 (or made plans to return it), according to the newsletter Real Estate Alert, reporting in April. Other funds have released investors from their capital pledges in return for extending investing deadlines on money already committed, the newsletter added. (The publication has not updated those April findings, however.)
The good news, says Michigan Avenue President Thomas Meador, a former executive of American Express' Balcor Co. realty group, is that bank regulators in some regions are beginning to pressure more lenders to take capital hits and unload some of their distressed assets. As more supply comes into the market, Michigan Avenue-which takes minimum investments of $250,000 and touts targeted internal rates of return of better than 25% over five to six years-plans to raise more money from advisors and develop custom funds for family offices, says Jonathan Reinsdorf, a senior vice president of the firm.
Private distressed real estate funds generally charge the standard limited partnership management fee of 2% of assets raised and 20% of realized profits, advisors say. Lower-yielding non-traded REITs take investments as low as $10,000 and charge management fees of 1% to 1.5% while keeping about 15% of the performance gain.
Experienced real-estate operators, ranging from giants such as Starwood Capital to niche managers, say that opportunities today go beyond direct investing in properties. These managers are also being approached by delinquent borrowers to design custom solutions. Such solutions might allow borrowers to find ways to repay bank loans and maintain at least a small interest in their properties.
"The product today is with existing borrowers who have defaulted on their loans but still control the assets," says Mark Bolour, the 38-year-old chief executive of Bolour Associates, a family office in Los Angeles that expects to make $200 million of bridge loans and other financings in exchange for a majority stake in the borrowers' properties through 2012. Bolour, who invests his family's capital as well as money for other family offices, says many investors prefer direct financings to passive investing in funds. "Since the meltdown, they don't trust many fund managers and they're not interested in owning a tiny percentage of a fund that's invested in 50 different properties," he says.
Bolour targets 10% to 12% returns on debt and internal rates of return of 25% or higher on equity.
Fund managers say the problem isn't trust as much as it is persuading investors to emerge from the lingering shell shock induced by the 2008 meltdown. "Their biggest concern is liquidity," says Reinsdorf, noting that his Real Estate Opportunity Fund plans to begin paying dividends early next year to limited partners out of the rents and other cash flow generated by fund properties.
Alexander Haverstick, whose New York-based firm Boxwood Strategic Advisors specializes in improving cash flow for wealthy investors, isn't convinced. The wealthy clients he works with are concerned about the weak economy and are generally loath to lock up money in workout situations.
"Real estate used to be about location, location, location," he says. "Now it's about liquidity, liquidity, liquidity."