Focus on US core leaves secondary markets open

With equity and debt investors concentrating on the country’s key metropolitan markets, fund managers could be missing out on potential deals in the middle of the US.

Much has been said about the focus of investors on core real estate markets and assets in the US. For one Denver-based investment manager, however, the continued call for deals in gateway cities has proved beneficial as it instead sources deals with little competition in the country’s secondary markets.

Last month, Baceline Investments closed on a 69 percent leased retail centre in Lincolnshire, Illinois, that was acquired from lender Citigroup for roughly half its 2007 sales price. The firm paid just $12 million for the Village Green Lifestyle Center after Citi foreclosed on the property, which also has an office component, when borrower Special Asset Acquisition defaulted on its $22.8 million mortgage.

Institutional buyers still are really focused on the Class A properties in the first-tier cities. That’s fine for those not afraid to buy at a five percent cap rate.

Baceline Investments managing partner David Puchi

As a small fund manager typically targeting deals valued between $5 million and $30 million, the Lincolnshire transaction is the largest dollar investment Baceline has made since 2008 and is just the third acquisition it has closed in the past 18 months.

However, managing partner David Puchi said secondary real estate markets in the US – notably the “heartlands” stretching between Texas and Kentucky – were proving increasingly fertile ground for sourcing deals. “Institutional buyers still are really focused on the Class A properties in the first-tier cities. That’s fine for those not afraid to buy at a five percent cap rate,” he said. “But we are buying pretty decent real estate at cap rates between 11 and 15 percent by targeting secondary markets.”

Baceline is expected to close on its fourth transaction this week, a discounted conduit loan secured against a retail centre in Louisville, Kentucky, for around 47 cents on the dollar. “There is good value in the middle of the country, and there is good real estate that is under financial distress,” Puchi said.

Puchi noted, though, that Baceline was playing in a field with limited competition. “The local buyers can’t get the debt easily, and there is just not that much other competition.”

Industry professionals repeatedly have commented on the bifurcation of demand for US real estate between core markets and assets and “everything else”. Senior executives interviewed in the latest Emerging Trends report from the Urban Land Institute and PricewaterhouseCoopers said many secondary and most tertiary markets don’t appear on investors’ radar screens. “You see no demand, no capital and no interest. There’s no near-term growth in office or retail and no need for new development,” one professional said.

Puchi concedes that secondary market deals require plenty of upfront due diligence and asset management skills once a deal has closed. But he said current industry perceptions that secondary market deals should be largely avoided was false, arguing that both the Lincolnshire and Louisville deals were sourced from established financial organisations, Citigroup and a special servicer.

“We are seeing financial institutions starting to sell their assets after being foreclosed on. And in the markets we are looking at, it is sometimes a fire sale of the properties,” Puchi said.