Friday Letter A land of opportunity?

One of the main culprits in the dismal showings by the investment banks was the sub-prime mortgage crisis in the US. Non-prime lenders like New Century Financial have filed for bankruptcy as the residential housing market has cooled and the riskiest borrowers are increasingly unable to make their payments. Both banks took a hit—the fixed-income businesses at Bear Stearns and Goldman Sachs dropped by more than 21 percent and 24 percent, respectively, compared to the same quarter last year.

At a real estate conference in New York in late May, numerous panels discussed the effect that the sub-prime loan crisis would have on the world of private equity real estate. Some simply brushed the issue off as irrelevant. Others, particularly those investing in the multi-family residential market, saw it as pushing more and more former homeowners back into the rental pool. (The weakening of the for-sale housing market was cited as one of the factors behind the announced acquisition of Archstone-Smith late last month.)

On the other hand, for some distressed investors, the sub-prime mortgage blow-up offered a ray of light in a market that was otherwise buoyant with liquidity. Finding turnaround opportunities has not been easy as of late. Some vulture investors hold out hope for the homebuilding sector, while others see dollar signs in struggling retailers being hit hard by “category killers” like Wal-Mart. And now some firms are turning their attention to the sub-prime market. Earlier this month, Lone Star Funds acquired sub-prime lending company Accredited Home Lenders for $400 million (€305 million). In March of this year, Accredited also received a $200 million loan from San Francisco-based hedge fund Farallon Capital Management.

Still, there is by no means a consensus that the sub-prime slowdown is going to result in a bevy of new distressed opportunities. At real estate events around the world, it seems, professionals are trying to figure out how the sub-prime situation will affect them—if at all.

“Distressed merchandise doesn’t seem to be coming,” Andrew Davidson, a research and fund manager with Vectors Research Management, told the Greenwich Roundtable earlier this month. “Today’s losses are $60 billion to $80 billion of a trillion-plus market. This was an earnings event, not a systemic shock.”

But distressed investors shouldn’t lose all hope. Davidson continued: “This is a moderate event which could become a bigger crisis if the overhang of defaults rises. This could create a cascading effect.”