CMBS offers hedge funds an indirect route into real estate

Funds are looking to buy deeply discounted bonds in hope of gaining control of underlying assets

Real estate hedge funds may be down, but they are not all out. In May this year, the support of international quoted hedge fund Och-Ziff was crucial to the timely flotation of Max Property. Max, managed by Nick Leslau’s Prestbury, raised £220m, with Och- Ziff taking £35m as a cornerstone investor.

Max went on to make one of the few large distressed property acquisitions in the UK so far this year, buying the Industrious industrial portfolio at 44% of its peak value. Other hedge funds have kept a low profile. The timing of Cambridge Place Investment Management’s foray into European property in 2006 and 2007 was not so good. The hedge fund’s European real estate team left last year and since then little has been heard from replacement head of European real estate Candace Valiunas, or chief investment officer Stephen White.

However, the place to find hedge funds sniffing out undervalued property opportu-nities in 2009 was generally not the direct market, but the debt market and particularly secondary CMBS. “They have been looking to buy CMBS bonds at deep discounts and become the controller of the underlying assets,” says one adviser working in the securitisation field. Two such funds are The Children’s Investment Trust and Trafalgar Asset Managers, a secretive London-based hedge fund founded seven years ago, which last year sold a 20% stake to a fund managed by Goldman Sachs.

Activist fund attacks

TCI is the activist hedge fund founded and chaired by Chris Hohn, which gives much of its profits to charity. Last year TCI was reported to have given £484.3m to charity and Hohn to have donated his £1.7m salary. The fund is best known for its attack on ABN Amro in 2007, which helped force the sale of the bank.

Sometimes this CMBS-buying strategy goes wrong. The controlling class in more complex securitisations, with multiple tranches of notes, moves around according to the valuation of the underlying property. Usually, when the valuation ‘breaks’ in one class, the class above it then becomes the controlling class.

Many people were surprised, not least the class D note holders, when the portfolio of nine London office buildings underpinning the £1.15bn White Tower 2006-3 CMBS was finally revalued in June. “They thought the value would break in the class Ds,” says a source. In the event, the £929m valuation was so low that it broke in class C.

Some of the White Tower class C bonds traded at 18p in the pound soon afterwards. Recently, however, their price has almost doubled and there was a recent trade at 35p in the pound.

A third hedge fund buying structured bonds is Noonday Asset Management. The same source says: “Noonday is clever. It is looking at assets across the asset-backed securities space that are undervalued for particular reasons and buying, then holding them to maturity. It targets assets that have been over-marked down, but that will gradually come back in value.”

In fact, with property values increasing as fast as they are – 5.5% between August and November, according to IPD, and probably more like 15% for prime property – some classes that are underwater now may not be in the future.

Cheyne Capital recruited Ravi Stickney in January 2009 as portfolio manager of The Cheyne Asset-backed Fund. Stickney, who previously worked at ING Bank’s proprietary desk managing a €400m long/short ABS portfolio, was taken on by the hedge fund “to take advantage of the opportunities that have arisen from the dislocation in the ABS market”, according to Cheyne founder Jonathan Lourie.

Iceberg’s CMBS focus

CMBS has also been a focus this year for Iceberg Alternative Real Estate Fund, the hedge fund run by Reech Alternative Investment Management and CB Richard Ellis, which has delivered a positive 44% return since its launch in May 2007 and which Reech CBRE hopes will double in size next year.

Iceberg is a market neutral fund – neither net long or net short. Its team trades the relative value of the underlying real estate represented by different financial instruments, including property derivatives, equities, unlisted funds and CMBS. The fund is interested in any big price moves  in either direction.

Graham Barnes, a director at Reech CBRE, says: “There is certainly value in current prices and the way we would approach CMBS now is different from how we would have approached it nine to 12 months ago.”