While some private equity real estate firms believe that there aren’t many distressed opportunities left in the US, Oaktree Capital Management isn’t one of them. 

The Los Angeles-based alternative investment manager has differentiated itself by focusing on assets in secondary markets, typically in smaller transactions between $25 million and $75 million. In terms of both geographic location and deal size, they are the types of deals that many other private equity real estate firms have bypassed or overlooked.

Last April, Blackstone chairman Steve Schwarzman opined, “there’s not a lot of distress left.” However, during his firm’s earnings call last month, Oaktree’s new chief executive, Jay Wintrob declared that the volume of so-called zombie real estate – assets that are worth less than the face amount of its debt – “continues to be ample.” 

As $1.5 trillion of US commercial real estate debt is expected to mature through 2017, much of the underlying real estate is likely to be devalued, Wintrob noted. Oaktree’s real estate team, led by John Brady, continues “to track that like a hawk,” he said. 

A year ago, Oaktree chairman Howard Marks viewed such deals as growth opportunities that could offset potential increases in interest rates. “There aren’t a lot of buildings on Park Avenue that aren’t kind of maxed out,” he said, speaking at a Pension Real Estate Association conference in March 2014. With zombie real estate, “there is room for improvement, in the physical plan, in the net operating income, and hopefully in the cap rate.”

In an investor presentation on its latest global real estate fund, Oaktree Real Estate Opportunities Fund VII, Oaktree identified zombie real estate as one of the main opportunity drivers in commercial property. “Over-leveraged and under-capitalized properties create a vicious cycle of value destruction,” the presentation said. In the document, the vicious cycle was illustrated in five steps: 1) Property value less than debt amount, 2) No incentive to invest additional capital, 3) Inability to lease space at market rents and offer tenant improvements, 4) Loss of tenant improvements, and 5) Decline in property value.

“You gain control and put in a manager that turns it around,” explained one limited partner in the fund. “It sounds simple enough, but it needs to be executed correctly, through a manager that can make it attractive and draw in new tenants. Oaktree has a very good track record here.” 

One recent zombie real estate transaction, announced last December, was the acquisition of a 19-property Class A office portfolio located in Florida, Georgia, Texas, North Carolina, Kentucky and Virginia, in a joint venture with Banyan Street Capital. The assets were part of a 22-property portfolio that the seller, Parkway Properties, had purchased for $475 million. The 19 properties were 64 percent occupied as of September 2014.