The Pennsylvania Public School Employees’ Retirement System has committed $150m for the launch of Värde Partners’ first fund dedicated to small, sub-performing US property loans.
The Värde fund will invest in so-called “scratch and dent” loans – where borrowers have averted default by resuming payments – targeting discounted secondary market purchases of existing loans backed by office, industrial and retail properties typically smaller than $10m.
Värde has historically invested in non-performing loans, but Värde Scratch and Dent Fund, L.P.will be a new departure. It will be a first for PSERS as well, a spokesperson for the pension fund told Real Estate Capital. Värde’s long history and solid performance investing in distressed assets were among the factors that played into PSERS’ approval of the allocation, she said.
Aksia, PSERS’ fund manager, noted that the scratch and dent fund will target an “underserved market segment,” with an estimated $100 billion-plus of such loans held among banks’ balance sheets and within CMBS structures.
“It meets key criteria necessary to execute the strategy effectively, and will be doing so against a positive backdrop for commercial real estate pricing,” said Bruce Ruehl, a partner at Aksia, in a recommendation letter to PSERS’ board of trustees.
Värde, which acquired distressed-loan specialist FirstCity Financial Corp in May 2013, plans to raise between $300m and $500m for the fund, targeting loans with high loan-to-value ratios and low debt service coverage.
The firm declined comment, but Ruehl stated in his recommendation letter that the fund will “leverage the distressed credit and real estate investing experience of Värde with FirstCity Financial’s capabilities to source, underwrite, and modify or restructure commercial real estate loans.”
Aksia expects returns between 10% to 15%, with limited partners in the fund expected to receive semi-annual income distributions with at least an 8% annual yield.
The fund could make additional investments in tranches of small CMBS bonds, residential first lien modification loans and second lien performing loans; and it may originate new high-yield loans including whole mortgage loans, bridge loans and mezzanine loans.
Värde and FirstCity, which first formed a partnership in the late 1990’s, have invested $875 million in approximately 3,000 individual loans with nearly 2,000 borrowers; and they jointly underwrite $4bn to $5bn of secondary commercial real estate loans annually, according to Aksia.