Tuesday, February 9, 2010

‘Blind Pools’ Falter as Ziman, Callahan Plan Property Comeback

Bloomberg News

Feb. 9 (Bloomberg) -- Richard Ziman and Timothy Callahan want to raise money in the equity market after selling their real estate companies for a combined $12 billion before the property crash. Investors may balk at bankrolling their return.

Ziman, former chairman of Arden Realty Inc., and Callahan, who ran Trizec Properties Inc., have each filed to offer shares in so-called blind-pool companies, which seek to raise money before owning any assets. They plan to use proceeds from the deals to acquire discounted office properties, hoping their talent and track records will lure investors.

Their timing may be wrong. Recent blind-pool stock sales have been cut in size or canceled, or the shares are treading water, amid a slump in demand for initial public offerings. Meanwhile, real estate owners are trying to hold onto distressed or defaulted properties rather than unload them at fire-sale prices, leaving few buying opportunities.

“Blind pools have huge negatives and only make sense if they have the perfect management and the perfect opportunity,” Mike Kirby, chairman of Newport Beach, California-based Green Street Advisors Inc., a research firm focused on real estate investment trusts, said in an interview.

Almost $1 billion of commercial real estate-related IPOs registered as blind pools have been withdrawn or postponed in the past year, according to data compiled by Bloomberg. An additional $3.9 billion of deals are in the pipeline. Five of the seven blind pools that raised about $2 billion did so before October, the data show.

Terreno Flops

Terreno Realty Corp., a San Francisco-based fund formed to buy industrial properties, postponed a $200 million sale Jan. 25 after reducing it by a third, and cut it again yesterday by 13 percent. The company is set to price the offering today, according to Bloomberg data.

Fairfield, New Jersey-based Chesapeake Lodging Trust raised 40 percent less than it sought, and the stock’s total return including reinvested dividends is down 5.5 percent after its Jan. 22 debut. Pebblebrook Hotel Trust, based in Bethesda, Maryland, is up 0.45 percent since going public Dec. 8.

Blind pools are risky because “the commercial market is in abysmal shape” and investors are worried the economic recovery will sputter amid high unemployment, said Robert Edelstein, a professor specializing in real estate at the University of California at Berkeley’s Haas School of Business.

The U.S. employment picture showed signs of improvement in January, with the jobless rate unexpectedly falling to 9.7 percent from 10 percent the previous month, the Commerce Department said Feb. 5. Unemployment touched a 26-year high of 10.1 percent in October.

Commercial real estate transactions declined 64 percent last year to $52 billion, data from researcher Real Capital Analytics Inc. show.

Distressed ‘Overhang’

Sales of commercial mortgage-backed securities, or CMBS, fell to $12.2 billion in 2009 from a record $237 billion in 2007, removing a major source of financing for building owners, according to JPMorgan Chase & Co. in New York, the second- largest U.S. bank. Delinquencies for loans packaged into CMBS rose to a record 6.5 percent in January from 1.5 percent a year earlier, Trepp LLC, a New York-based research firm, said Feb. 1.

Only 14 percent of an estimated $150 billion in distressed U.S. commercial real estate has been taken back by lenders, according to Jessica Ruderman, director of research services at New York-based Real Capital.

“There’s an overhang of real estate that no one is quite sure what will happen with,” Edelstein said. “The market is starting to recognize the complexities of owning troubled real estate.”

Ziman and Callahan sold their companies a year before the collapse of subprime residential mortgages led to the worst financial crisis since the 1930s and a more than 40 percent decline in commercial property values from their 2007 peak.

Beating REIT Index

Ziman, 67, was chairman of Arden Realty when Fairfield, Connecticut-based General Electric Co. agreed to buy it for $3.2 billion in December 2005. Arden, which Ziman founded in 1990, had 116 office properties with 18.5 million square feet in Southern California.

The Los Angeles-based company went public in October 1996 and returned 326 percent to shareholders, including dividends, through the announcement of the GE deal, according to a Dec. 18 IPO prospectus filed by Ziman’s new company, Halvern Realty Inc. That compares with a 237 percent return by the MSCI US REIT Index.

Halvern, based in Los Angeles, is seeking to raise as much as $400 million, according to its filing with the U.S. Securities and Exchange Commission. The company intends to buy and manage Southern California office properties and will be organized as a real estate investment trust. REITs must distribute at least 90 percent of their taxable income to shareholders, and don’t pay corporate taxes on that amount.

Zell’s CEO

Callahan, 59, was chief executive officer of Chicago-based Trizec Properties from 2002 until it was bought for about $9 billion by New York-based Brookfield Properties Corp. and Blackstone Group LP of New York in October 2006. He was CEO of billionaire Sam Zell’s Equity Office Properties Trust, also in Chicago, from 1997 to 2002.

Under Callahan, Trizec returned 189 percent, compared with a 125 percent gain by the REIT Index, according to a Dec. 11 prospectus by his new company, Callahan Capital Properties Inc. Equity Office returned 89 percent while he was in charge, twice the rate of the index.

Callahan’s REIT plans to buy prime office properties initially in Boston, Los Angeles, New York, San Francisco, Seattle and Washington, according to its filing. The Chicago- based company may raise as much as $500 million in the IPO.

Ziman declined to comment, citing the so-called quiet period required before an IPO. Callahan didn’t return calls seeking comment.

IPO Slump

The IPO market is slumping after the largest stock-market rally since the 1930s revived deals in the last four months of 2009 from a record slowdown that followed the credit crisis.

This year, Boca Raton, Florida-based FriendFinder Networks Inc.’s $240 million initial offer and Los Angeles-based Imperial Capital Group Inc.’s $113 million sale were pulled; Cambridge, Massachusetts-based Ironwood Pharmaceuticals Inc. cut its share price by 30 percent; and Fort Lauderdale, Florida-based Patriot Risk Management Inc. delayed a $204 million deal.

The Standard & Poor’s 500 Index has lost 5.1 percent in 2010, including dividends.

U.S. IPOs will triple in 2010 to $50 billion, according to an estimate by Barclays Plc, the second-largest U.K. bank. Even with a projected rise, real estate investors may favor trusts that already own buildings rather than blind pools, said Craig Guttenplan, a New York-based REIT analyst for CreditSights Inc.

“People are really wary of those,” Guttenplan said.

REIT Appeal

The load, or commission, for blind pools can reach 14 percent and covers underwriting and legal fees and general costs, according to Green Street Advisors’ Kirby. Terreno had a 10 percent load, one reason the IPO didn’t pass an “economic merit” test, he said.

U.S. office REIT share prices are trading at 7 percent above the underlying value of their real estate and are a safer investment than blind pools, Kirby said.

Blind pools face competition from other investors. Private- equity managers raised $21.4 billion for 50 North America real estate funds last year, according to data compiled by Preqin Ltd., a London-based research firm. Barry Sternlicht’s Starwood Capital Group LLC in Greenwich, Connecticut, has $900 million in a hotel fund, managing director Marc Perrin said Nov. 6 at a real estate industry meeting.

Capital Raises

The REIT boom that began two decades ago raised almost $27 billion in initial share sales from 1993 through 1998, according to the National Association of Real Estate Investment Trusts in Washington. More than 150 real estate companies went public in that period, and “few” of them were blind pools, said Michael Grupe, executive vice president for research.

Last year, facing tight credit markets and needing to pay down debt, almost 90 existing REITs raised more than $21 billion in secondary share offerings, the most since 1997, NAREIT data show. Companies also raised more than $10 billion in unsecured debt.

Still, buildings aren’t changing hands, and even established REITs can’t find deals because owners expect values to rise following the government’s massive support of capital markets, according to Dan Fasulo, managing director of Real Capital.

“I don’t think we’re going to see the wave of distressed opportunities that everyone thinks is out there,” Fasulo said. “Lenders aren’t in a forced position at all. They’re not giving the good stuff away.”

To contact the reporters on this story: Dan Levy in San Francisco at dlevy13@bloomberg.net Brian Louis in Chicago at blouis1@bloomberg.net .