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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   October 2008

How to Win Investors’ Business

Brokers can stay relevant in today’s markets by becoming assets to fund investors

_2008-10__Caton_spotCommercial brokers are starting to wonder how to stay in business while the market works through its liquidity, credit and property deleveraging process. The name of the game is loan investors -- particularly, B-piece buyers from Wall Street.

These investors are holding the trump cards for resurrecting everything from small-balance commercial loans -- aka, those of $5 million or less -- to the large-loan commercial-mortgage-backed-securities (CMBS) deals. They also hold the key to stabilizing the residential and collateralized-debt-obligation (CDO) space. And they are not ready to move until they either see a turnaround or receive a high-enough return to take on the risk.

The current market dislocation is not because of the absence of available investment capital. It is a crisis of confidence in the quality and value of loans and the securities they back. And brokers should closely watch the movement of market spreads between fixed- and adjustable-rate loans, as well as the spreads between high-quality and high-yield debt and securities. On any given day, the movement of these spreads determines if the market equilibrium for buying loans is closer to the buyers’ bids or sellers’ asking prices.

Brokers who wish to remain relevant until originations come back would be wise to become friendly with the fund investors -- and to keep a close watch on the residential and commercial markets to see which way the funds are flowing.

Antsy residential investors

Although many commercial brokers do not handle loans in the residential market, they’re quite aware that trends in that sector greatly affect the flow of funds in commercial.

The residential market doesn’t need to see home prices stop declining for the mortgage market to stabilize. Although that flies in the face of prevailing wisdom, consider that when home prices stop falling, a lot of the upside investment potential for value-adds and distressed buyers will evaporate quickly.

Sellers will almost immediately gain the upper hand. Private equity and hedge funds will begin throwing large blocks of capital at these businesses, and the result may be chaos and a lot of bad loan purchases.

In addition, fund managers will be on a buying binge when the rest of the world says that residential properties are on the upswing. Due-diligence shops will be overwhelmed, which could lead to more mistakes and mispricing.

This side of the industry seeks investors willing to buy paper on the street at something that resembles a reasonable bid -- based on achieving a reasonable risk-adjusted return and a plan to “work” the real estate asset. These could be investors who hire real estate agents to rent properties behind loans until a market uptick, when those properties can be sold, for example. Until then, residential banks and lenders will continue writing down assets, even though they have no intention of selling at those prices.

A number of buyers in the default-loan acquisition and servicing space are starting to kick the tires of loan portfolios, however. Their investors are getting antsy about not buying into what they see as good value in real estate and mortgage portfolios and even some securities.

For brokers, these investors are worth watching.

Wooing investment-fund managers

While the residential market waits for investors to return, the market for commercial properties has not yet been hit as badly -- and it is not likely to spiral down that far because too much capital is still chasing the commercial market.

Capital raised by private equity, pension and endowments, and hedge funds earmarked for real estate ventures is still strong. These funds are sitting on the sidelines, waiting to get into the commercial market.

But right now, there really isn’t much for these investors to buy in terms of properties being offered at fire-sale prices. So they just sit and wait.

Soon, however, investors will demand action from their fund managers. The vast majority of these funds label themselves as “opportunity funds,” which generally indicates they are looking for distressed mortgages or properties to buy at dirt-cheap prices.

But the big players, such as the real estate investment trusts, have been able to refinance good assets so far. What are left are either the weak properties with weak sponsorship or deals that are so big that only a limited universe of people can go after them.

These opportunity funds know that the good pickings are getting slim. So distress buyers may blink first and start buying, albeit cautiously. In fact, many of these funds -- which are usually looking for investment returns of more than 25 percent -- may have to modify their investment objectives. They may have to settle for numbers closer to the low- to mid-teens to start.

Right now, anything that resembles decent mezzanine or bridge deals are getting snapped up before they are even put out on the street for bid. And the mezzanine and bridge funds that are doing well are the ones with strong asset management attached to them.

If brokers have capabilities as proven asset managers, they should get friendly with these investment-fund managers.

A new paradigm

A good place for commercial brokers to be today is getting cozy with these fund investors -- people who want to buy loans but who are not necessarily established lending brands.

Some of these investors may have to go the route of actually funding loans, instead of relying on buying them from increasingly hard-line lenders and sellers. If brokers can become origination partners for a fund manager -- originating only deals that manager wants to buy -- they can have a good place in this business now and in the future.

But this kind of business is not going to just any broker shop with a nice business card and a slick sales pitch. These investors will seek brokers who can present a brand with an asset-management shop to boot.

Brokers who have asset-management experience may wish to polish their résumés and skills, and start pitching those skills to fund managers and investors. Brokers may have to approach high-quality borrowing clients and ask them to lend their good name and property-management skills and history to the broker’s pitch in order to win business from investment funds.


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