Needles in the hay

The short, yet tumultuous, history of the private equity real estate industry can probably be summed up in one word: distress.

From the beginnings of the asset class in the wake of the S&L crisis to the migration of US opportunity funds overseas—first into Europe in search of beleaguered French loan portfolios, later into Asia after the region's currency crisis and Japan's economic decline—distressed assets, distressed sellers and distressed economies have been at the forefront of the industry's development and growth.

And that has been a good thing. Like horror film aficionados and hockey fans, opportunity fund managers are drawn to blood: the more of it in the streets, the more profits to be reaped by contrarian investors.

Today, of course, bloodbaths are in short supply. The real estate landscape is no longer characterized by systemic, market-wide distress. Liquidity is high, prices are higher and finding a distressed asset with the right risk-return profile is more difficult than ever.

Like horror film aficionados and hockey fans, opportunity fund managers are drawn to blood: the more of it in the streets, the more profits to be reaped by contrarian investors.

Which is not to say they do not exist.

While the global property markets of today do not exhibit the dislocation of markets past, the nature of modern-day capitalism dictates that, at any point in time, somebody somewhere is losing their shirt. It's just that these days, such levels of distress are only found in very specific niches: for example, Silicon Valley office properties in the wake of the dot-com bubble or a debt-laden German telecom company shedding noncore properties.

Other examples abound. For instance, Chinese state-owned banks continue to dispose of billions of dollars worth of non-performing property loans, albeit more slowly than anticipated. In Germany, much of the real estate activity in recent years has focused on distressed residential assets or debt-laden corporate and government sellers—even if the prices paid reflect a rosier scenario. And at a recent conference hosted by PERE, David Marks, a managing partner at London-based opportunistic investor Brockton Capital, offered up a laundry list of distressed deals from the past year, including everything from high street pub chains to Swissair to the Ark, a London office complex.

“If you look under enough rocks, there is always some corporate or asset-level distressed,”Marks said.

In the pages that follow, our journalists look under some of those rocks to identify specific examples where private equity real estate firms and other opportunistic investors are capitalizing on distressed situations. We look first to Italy, where the country's struggling economy, though overshadowed by Germany's lackluster performance, has nonetheless proven fruitful for a number of foreign and domestic investors, particularly in the nonperforming loan arena. In the US, we analyze the pockets of distress in certain residential markets, primarily South Florida, where some fund managers are gearing up for what they see as the region's inevitable correction. And we speak with Gil Tenzer, a co-founder of the distressed focused hedge fund and real estate investor Contrarian Capital Management, who offers his thoughts on when the cycle will break his way.

As the example of condos in Miami (or Las Vegas or San Diego) makes clear, there are many markets where distress and dislocation may be just around the corner. In regions throughout the world, interest rates are rising, construction costs are skyrocketing and talk of a real estate correction continues to percolate. It may still be a boom market, but as any wizened real estate investor will tell you, markets can change overnight. And the sunny landscape of today could turn into a much cloudier picture tomorrow.

Some private equity real estate investors are licking their chops.