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Why investors are balking at IPOs of new vulture mortgage funds

Tom Barrack is considered one of the savviest commercial real estate investors of the last 20 years. But his bid to lure public investors to join with him fell far short Wednesday.

Barrack, the 62-year-old founder of L.A.-based real estate and private-equity giant Colony Capital, wanted to raise $500 million via a new real estate investment trust that will buy troubled commercial property debt.

Instead, his Wall Street investment bankers could rustle up only half that sum from investors. The initial public stock offering of Colony Financial Inc. raised $250 million by selling 12.5 million shares at $20 each, instead of the 25 million shares that Barrack wanted to issue.

What went wrong? The deal tripped in large part because too many of Barrack’s rivals -- including Barry Sternlicht of Starwood Capital and Leon Black of Apollo Group Management -- have raised or are trying to raise money for the same kind of vulture funds. The market is becoming at least temporarily glutted, as I noted in this post earlier Wednesday.

Beyond that, many investors just don’t like the structure of the deals. Shareholders of these real estate investment trusts will pony up hefty ongoing management and incentive fees from trust assets to pay Barrack and the other independent advisors. The advisors will work under contract to find and manage opportunities in distressed commercial mortgages for the trusts.

Fortunecover

But what shareholders of the REITs will reap is a big unknown. The return to investors will depend on the income generated by the loans and any capital gains the trusts earn by eventually selling the debt -- less any losses on troubled loans that go from bad to worse.

"There are going to be opportunities in commercial mortgages and these guys are going to be able to take advantage of that," said Mike Kirby, a principal at real estate securities research firm Green Street Advisors in Newport Beach. But he believes the structure of the trusts is "universally bad," assuring a profit for the managers while potentially shortchanging investors.

Many investors buy REITs to earn a continuous stream of income, Kirby noted. Because vulture funds are by definition opportunistic, "The consistency [of income] definitely won’t be there" for shareholders, he said.

Kirby asserts that it’s smarter for investors who want to play for bargains in the depressed commercial real estate market to stick with conventional REITs such as Vornado Realty Trust and Simon Property Group, which own property rather than mortgages. Property REIT managers work directly for shareholders, as opposed to the hired-gun management structure employed by the new vulture mortgage REITs.

An analyst at one brokerage that helped underwrite the Colony Financial deal said he had plenty of calls from interested investors but that many didn’t like the unavoidable "blind pool" aspect of the deal.

What’s more, he said, investors know that a key reason private-equity shops are turning to the public market to raise funds is that many of their pension funds and other usual sources of money are tapped out. In other words, the public market is the fallback option, which also makes those investors suspicious.

Finally, this analyst said, given that many of the new mortgage REITs that have come public in recent months immediately fell below their IPO prices when trading began, investors figure they may as well wait to buy any new deals, including Colony.

The mentality, the analyst said, is: "If you know it’s going to trade down, why buy in the IPO?"

Colony shares will begin trading on the New York Stock Exchange on Thursday under the ticker symbol CLNY.

Apollo Group’s Apollo Commercial Real Estate Finance REIT, which sold 10 million shares at $20 each on Wednesday -- also raising just half what the firm had hoped for -- will begin trading under the symbol ARI.

-- Tom Petruno

Image: Tom Barrack on the cover of Fortune magazine in 2005

 
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