Opportunists hunt deals in commercial real estate

Just about every player in the real estate business—whether individual investor, private-equity fund or publicly
traded company—is trying to raise capital to take advantage of what they see as an inevitable shakeout in commercial
property.

More than $3 trillion in real estate loans, many of them the short-term and interest-only variety, come
due in the next five years. Few owners have any equity left in their buildings, let alone enough to meet the higher thresholds
banks are demanding for refinancing. And funding from commercial mortgage-backed securities—a $1 trillion funding source
just three years ago—has disappeared entirely.

Meanwhile, banks have resisted calls to take drastic markdowns
on their real estate portfolios, opting instead to wait out the market for more favorable valuations or an assist from Uncle
Sam.

“Equity has been wiped out in virtually every real estate transaction—the question is, can you
hold on until the market bails you out?” said Gene Zink, founder of Chicago-based Strategic Capital Partners LLC and
a former longtime executive at locally based Duke Realty Corp.

“At some point, the regulators are going to
call the banks out on bad loans,” he said. “At that point, there will be some pretty dramatic decreases in value
in real estate.”

If banks are forced to reduce values to realistic levels, buyers are likely to come off
the sidelines. More sales would give brokers and leasing agents an opportunity to compete for new business. And it would be
good news for tenants since properties with murky ownership are less likely to pay broker commissions to attract deals or
spring for tenant buildouts, said John Robinson, executive vice president in the local office of Chicago-based Jones Lang
LaSalle.

“The whole market is on hold right now because value hasn’t been determined—foreclosures
will set the floor,” Robinson said. “Banks need to either prove a property is worth what they have on their books,
or get it off their books.”

Potential local targets for vulture investors include M&I Plaza, the Maxwell
condo project downtown, Woodfield Crossing on the north side, and Metropolis mall in Plainfield.

Where banks used
to loan 75 percent of a building’s value, now they’re doing 50 percent, said Zink, who expects the government
will step in with programs to add liquidity to the commercial market like it did with the first-time homebuyer tax credit
for residential property.

“The only transactions that are happening are fire-sale transactions where someone
has thrown in the towel,” he said. “Clearly, as we recapitalize the real estate industry, the losers will be people
who borrowed money two, three or five years ago. The winners will be those who have new capital that can take advantage of
the pain that results from the refinancing.”

Zink’s Strategic Capital Partners has a $1 billion opportunity
fund that’s fully invested, and it has set aside a “large amount of money” to see its properties through
any wide-scale revaluation.

He thinks publicly traded real estate investment trusts, or REITs, will be the biggest
players in snapping up distressed properties since they have access to public capital. That includes locally based Simon Property
Group Inc., Duke Realty and Kite Realty Group Trust, where Zink serves on the board.

Dozens of private funds claim
to have raised hundreds of billions of dollars to buy distressed assets, but Zink is skeptical. He figures some of the funds
are exaggerating their numbers to attract attention from potential investors and the banks that hold properties they are targeting.

One group that has had success raising money is Chicago-based Michigan Avenue Real Estate Investors. The company is
about halfway toward its goal of raising $50 million for an opportunity fund that will buy up to $250 million in distressed
real estate. The fund is buying properties in Chicago, San Antonio and Denver and might buy in Indianapolis soon.

The fund’s focus is on residential properties, particularly unfinished or unsold condo developments that can be converted
into apartments until market demand returns for condos, said Tom Meador, the fund’s CEO and an IU grad.

A
big gap remains between what buyers are willing to pay and what sellers will accept, Meador said, so for now he and his partners
are trying to cultivate relationships with banks that ultimately will decide which property loans are renegotiated and which
are foreclosed.

Banks will favor funds that have capital to close on such deals. Among the investors in previous
funds from Michigan Avenue is Chicago Bulls and Chicago White Sox Chairman Jerry Reinsdorf.

The company launched
its first real estate opportunity fund in early 2007 after the principals got a peek at some bank balance sheets.

“We knew the banks had troubles, but when we got into their portfolios, oh my gosh,” Meador said. “They’re
going to have to move eventually. They can’t sit on these problems in perpetuity.”

It might take a
little prodding from the banks’ auditors or the federal government, he said.

The fund likes Indianapolis
for its stability and growth and may also buy single-family home lots if the price is right.

Chairman Bob Judelson
is predicting a boom in residential real estate to rival the 2005 run. The country’s population continues to grow, and
people need a place to live.

“If Ford or GM stopped building cars for two years, Americans would be short
of cars,” Judelson said. “If we don’t build lots, there won’t be anywhere to stick a home.”

Timing has worked out better for some investors than others. A group led by locally based Venture Real Estate tried
to put together a $30 million vulture fund in December 2007, but the effort fizzled with just a few million dollars in commitments.

The group, which included prominent developers Paul Kite and Paul Rioux and Marion County Prosecutor Carl Brizzi,
wanted to buy unsold condo properties in Florida but couldn’t find enough tangible properties to show potential investors,
said Jeff Sealey, who briefly served as the fund’s managing director.

The timing is better now, but challenges
remain.

“The bank owns half the real estate in town,” said Sealey, a former lender at Charter One.
“The problem is finding the money and getting people off the fence.”•