Twenty years after the savings and loan crisis in the States destroyed the fortunes of some of the world’s richest fortunes – and fattened the net worth of others – new capital is massing to buy distressed loans and properties the U.S., and other governments cannot or will not buy this time around.
Traditionally called “Vulture Funds”, (although they prefer the term “opportunity funds”). These investors’ strategy is the simplest; their goal is to snap up faltering assets such as property and real estate and mortgage-backed securities on the cheap, then cash in when prices recover. It is the epitome of the cliché “buy low sell high”.
According to one stateside contact, a Dallas based real estate developer Craig Hall “It’s a lot of risk-taking and a lot of work”, Craig and joined forces with commercial real estate broker Herbert Weitzman to purchase distressed real estate.
“We’re going to see one of the greatest transfers of wealth in our lifetime.”
The transfer of wealth he is talking about is not necessarily from taxpayers to rich investors, and no one apart from the truly hard-hearted is enjoying watching all of the repossessions and foreclosures that are at the root of the current crisis.
The transfer of wealth these guys are talking about is from the wounded and limping financial institutions and desperate property owners to people (like him) who are ready with cash waiting to relieve them of their troubled or indebted asset.
If a homeowner defaults on a mortgage loan of $/£/€ 100,000, it can often be cheaper and more efficient in terms of cash flow for the bank to sell the loan on at a knock down price. For example rather than go through the costly foreclosure process only to end up owning the underlying real estate that will then owe them even more due to the cost of the foreclosure process, it may be better just to take $20,000 in cash to rid themselves of the bad asset and increase liquidity instantly.
You have to bear in mind that having a bad debt on the books not only affects a lender’s cash flow, but also affects their own ability to borrow by a ratio of 9:1. So that one bad loan of $100,000 prevents the banks from borrowing a further $900,000.
Waiting for a bottom
There are of course many investors waiting to call a bottom to the market before diving in.
Many Analysts predict that house prices still have a ways to fall in many U.S. and global markets. Sliding property prices fuel foreclosures and repossessions, volumes of which are still on the increase. That will continue to hurt the value of the mortgage-backed securities that are now taking down banks and helping global the financial system grind to a halt.
Those investors eyeing up distressed assets and distressed real estate or property assets in particular include high net worth individuals, pension funds, hedge funds, and endowments, not to mention the man on the street.
One extremely high-profile private equity firm, Lone Star Funds, has already gambled big on distressed mortgages.
Lone Star is headed by John Grayken, who worked with Fort Worth billionaire Robert Bass to snag distressed properties after the savings and loan bust of the 1980s. This strategy back then made Grayken a billionaire!
In July 2008, Lone Star agreed to shell out $1.5 billion and assume $4.4 billion in debt to buy a mortgage portfolio with a paper value of $9.3 billion. That works out to about 63 cents on the dollar.
The same month, the firm agreed to pay Merrill Lynch & Co. $6.7 billion for a $30.6 billion portfolio of mortgage-backed assets – or 22 cents on the dollar. Lone Star even got Merrill to help finance the deal.
Right now mortgage notes and mortgage backed securities can be picked up at 18 cents in the dollar from brokers working all over the world and at all levels of investment with excellent follow up and management platforms to ensure the notes can be restructured effectively.
Mr. Hall, the Dallas developer, is mulling over distressed paper assets such as mortgages along with hard assets such as commercial real estate, residential lots and condominiums that might be purchased directly from distressed owners.
The big unknown is how to value such assets.
“If you have a subdivision with 300 lots and nobody’s bought a house there in a year or two, what is that worth?” he mused.
But unlike the real estate flipping that helped fuel the housing bubble a few years ago, Mr. Hall said these new opportunities will require patience and staying power.