Managers desperate for big infusions of cash

Real estate managers are making a mad scramble to raise cash.

Their two top priorities this year are refinancing maturing debt and raising capital, according to a recent survey of more than 40 real estate money managers by Ernst & Young LLP of New York. Both goals will be extremely challenging to achieve, said Gary Koster, the firm’s Americas leader for real estate fund services.

“We’ll be talking about 2008 and 2009 for decades,” he said.

Cash and financing are hard to come by. Of the managers that responded to the survey, a vast majority (92%) said they generally or strongly agreed that as with other debt, lines of credit for a fund would be very difficult to obtain.

Fifty-four percent of survey respondents said that the denominator effect — meaning the drop in stocks’ pushing up investors’ exposure to real estate and alternative investments — would result in investors’ reducing their investments in new real estate opportunities. Forty percent said that they strongly agreed with the statement that new fund sizes this year would be smaller.

Although most of the managers surveyed (63%) said that they weren’t concerned about the potential for limited partner defaults on capital calls for existing funds — though they were monitoring the situation closely — 27% said that limited partner defaults were “a pervasive concern requiring management’s close attention.”

Companies are struggling to survive, and this is only the beginning, Mr. Koster said. “Consolidation is inevitable,” he said.

Ted Leary, president of Crosswater Realty Advisors, a Los Angeles-based real estate consulting firm that wasn’t involved with the Ernst & Young survey, agrees. “The general consensus in the business is that there will be 20% to 30% fallout,” he said.

“It will impact the full spectrum of managers, big to small. When values are down 30% to 50%, it cuts the heart out of the financial model, especially when there are no incentive fees on the horizon.”

The difference between the managers that remain and those that “fade into the annals of history” are those that realize that real estate inevitably has a down cycle, Mr. Koster said.

When times were good, real estate managers loaded up on higher and higher amounts of debt. For funds that closed in 2006 and 2007, 20% of survey respondents indicated that the approximate amount of debt-to-equity on deals was up to 2-to-1; 31% stated that they employed two to three dollars of debt to every dollar of equity; and 26% said they used three to four times the amount of debt as equity.

A modest decline in a highly leveraged property’s value causes huge drops in the value of the investment, Mr. Koster said.

Some once highly prized properties in plum locations are now selling for a fraction of the price that they fetched just two or three years ago.

And as of April, there was more than $86 billion in distressed U.S. real estate, according to Real Capital Analytics Inc. in New York.

Some 41% of real estate money managers indicated that capitalization rates for stable-income-producing U.S. commercial properties would increase this year, pushing down property values further. Seventy percent said that cap rates — the ratio between the net operating income produced and a property’s fair market value or cost — already increased by more than 100 basis points in the 12-month period ended May 31; 25% of respondents said that cap rates increased more than 200 basis points.

This loss in value is having a disastrous impact on real estate money managers’ business models.

“Small managers, including spinoffs and emerging managers that got into the business in 2004 and even later, are under the greatest stress,” Mr. Leary said.

At Invesco Real Estate of Dallas, a unit of Invesco of Atlanta, executives said that the firm is well-positioned to weather the storm because its portfolio is half core and half value-added properties with relatively low amounts of leverage. For its core real estate investments, Invesco did deals ranging from all cash to as much as 30% leverage; for value-added properties, leverage went as high as 60%, said Max Swango, managing director and head of portfolio management.

The firm also has significant amounts of available capital, including the $500 million Invesco Real Estate Fund II, a value-added fund that it closed last summer.

Arleen Jacobius is a reporter for sister publication Pensions & Investments.