Distressed debt lures growing numbers of real estate investors


If an award were given for the most profitable single purchase of distressed commercial real estate debt, Miami's Omni Center would be a contender.

Real estate investors Jorge Perez, Jimmy Tate, and Sergio Rok looked at the Omni Center, a struggling mixed-use project, and saw a great redevelopment opportunity.

When they bought the $161 million note in May that represented the bulk of the $206 million mortgage, their vision called for first gaining control of the property through foreclosure and eventually embarking on a mixed-use redevelopment plan. Selling wasn't in the cards.

What they never expected was the Genting Group coming along four months later and buying them out at the full value of the mortgage, with plans to incorporate the Omni as part of Resorts World Miami. The group led by Mr. Perez walked away with a $61 million profit in four months.

"We didn't openly go out shopping that deal to sell it," said Matt Allen, chief operating officer for Mr. Perez's Related Group. "First and foremost, we're developers. The Omni site is one that we would have loved to develop. But it's not a bad amount of money we made in four months."

But before anyone thinks this is the new way to get rich quick, the Omni story is by far the exception rather than the norm.

Although purchasing distressed commercial real estate debt and distressed properties is gaining in popularity, "Buying distressed debt is a very risky business," said Ezra Katz, chief executive of Aztec Group, a Miami investment bank group that has also been purchasing debt.

"A lot of people don't understand the details. They smell a bargain and they take a risk. Unless you really know what you're doing, stay out. If you want to gamble, you might as well go to Las Vegas."

Although most investors are purchasing debt as a way to gain control of a piece of real estate, it is no guarantee. The debt buyer could remain the lender. Gaining control of an asset requires foreclosure, which can be a costly and lengthy process.

Related Group, as well as Mr. Tate and Mr. Rok, are among some of the bigger south Florida players in the distressed debt market. Most are typically buying a mix of distressed debt as well as distressed assets. Investments span all the asset classes from retail to multifamily apartments, office, and hospitality.

The key is identifying good-quality assets that are underwater because they were overleveraged during the boom, rather than underlying flaws in the real estate.

Buying distressed debt and assets has been a key part of Related Group's strategy in the past few years. The company has purchased about 30 assets for close to $500 million, including undeveloped land in Hallandale Beach, Plantation, and Fort Lauderdale, plus apartments in Myrtle Beach, S.C.

Although many institutional buyers are involved in the field, many bigger players are larger real estate organizations with the ability and manpower to quickly evaluate the potential deals. Buyers also must have the cash to fund a deal. It's possible to refinance some of the debt later, but closings tend to require quick turnarounds. Properties often need an additional capital infusion.

"To be competitive in this business, you've got to have ready capital available," said Jim Stine, chief investment officer of Ram Realty Services. "Most of these properties need some work. The borrowers have probably been in default for a year or more. They're not investing in the property and they're not caring for them."

Most recently, Ram closed on a $27 million note for a Plantation, Fla., shopping center anchored by a supermarket and an off-price apparel and gift ware store. In the past 2 1/2 years, Ram has acquired 58 distressed real estate notes with a total debt value of approximately $275 million.

For each property, the company paid 20 percent to 80 percent of face value. Ram has recently formed its third investment fund that will target about $500 million of additional distressed note acquisitions, as well as other investments.

Mr. Stine and others in the industry see no signs of the deal flow slowing anytime soon.

At the end of the third quarter of 2010, approximately $3.2 trillion of outstanding debt was associated with commercial real estate, according to the Federal Reserve.

Because most of the debt was financed during the boom years, the cycle could take as much as five to six more years to completely play out. An estimated $361 billion in commercial real estate debt expires in 2012 and $1.4 trillion expires between 2012 and 2015, based on a report from Deloitte.