Q&A

Founded in 1995 by Jon Bauer, Janice Stanton and Gil Tenzer, Contrarian Capital is a multi-strategy hedge fund focused on distressed opportunities. The Greenwich, Connecticut-based firm currently has over $4 billion in funds under management, including the Contrarian Real Estate Fund, which has a $250 million capacity. Here, Tenzer, who oversees the firm's real estate platform, speaks about Contrarian's focus on distress, the difficulty of finding opportunities in today's market and why every dog has his day.

Could you describe Contrarian's real estate platform?
Contrarian is a multi-strategy family of funds, but the one common thread is that the vast majority of the investments that get made here are true, hard-core distressed. So we are not an opportunity fund. Historically, approximately 80 percent of our investments have not utilized any leverage, for example.

A lot of the value creation here tends to be more in the process. A fair amount of our investments have been related to corporate bankruptcies. So when that blows up, we'll try and figure out if that creates any real estate opportunities. We owned a piece of the Enron headquarters building, for example.

What we're really good at is the ugly, really, really distressed one-off stuff, which is starting to pop up a little bit now, but not much.

What are the fundamentals of the market like today?
We raised our stand-alone real estate fund in late 2003 primarily from existing institutional investors of Contrarian. Back then, we felt that the market was finally about to correct. It was a couple of years after the whole corporate meltdown. Fundamentals were really poor. But, of course, we underestimated the impact of interest rates and the flight to hard assets. At the end of the day, capital overwhelmed the fundamentals.

Historically, it's hard to find a more cyclical business than real estate, where borrowers get 80 percent leverage just for showing up. And if you push at all, you can get to 90 or 95 percent. In that type of industry, which historically has had such clear cyclicality, to go through a 13-year period without some sort of significant correction is fairly incredible. And it has been very difficult, frankly, for people that are value investors.

Where are you looking for opportunities?
As you can imagine, we are extremely focused on Florida. If you want to eat cake, you go where the cake is. It's probably percolating there—plus the sheer size of that market—more than any other place. We have started to see more and more product coming out, but the bid-ask spread is still very significant. And in a way, that has been the story of distress for the past three to five years. You're going to see more transacting going on, not because the bid side has gone up that much, but because the ask will be forced to face reality.

For the next six to twelve months, I do think that the vast majority of opportunities will be in residential probably focused on a handful of obvious, larger markets. The problem is: it's too early to go in and buy these things. My guess is it's going to be a little bit of a needle in a haystack.

What do you think will drive the next downturn?
The way the market has evolved now, it's not really going to accelerate until the securitization markets start really shutting down. And that will not happen until the rating agencies clamp down and you start to experience more of a default rate. So far, default rates are still near historical lows. It's all sort of interconnected these days.

The system has become so good now at distributing risk, it's almost a question of what will stop it. The mispricing of risk that goes on in real estate is really no different than the corporate world. We think risk is mispriced across the spectrum. And the question is: What will jolt it into more of a realistic pricing? It's not an easy question to answer.

Are you finding opportunities outside the US?
We are certainly looking. Over the past couple of years, we have really expanded to Europe. Our biggest investment this past quarter was a distressed European hospitality play where we picked up a controlling interest in the company's unsecured debt. It helps that the firm has a European office because the spectrum of markets and investments we can look at is bigger. But more importantly, we are all slaves of what the market is giving us.

What are your predictions for the future?
It's an exciting time, I have to tell you. One of my favorite quotes of the past few months—“Every dog has its day.” We've been waiting for so long, and it feels like it's really our day. Or at least it's really starting. This is the beginning—not the end—of this correction. By the time it's over, it's going to spread beyond just residential in two or three big markets.