Financial Reform: CRE Buying Opportunity?

Paul Vlocker - The Financial Reformist

With the financial reform bill signed into law just a couple of weeks ago, I am interested to see how the legislation will change the landscape for major commercial real estate investors.  The new law puts constraints on investment banks’ ability to be both advisors as well as principal investors.  Some of the biggest and strongest real estate investors through the peak of the last cycle were investment banks housing advisory and principal investment business lines under one roof.  As a result of financial reform, however, investment banks like Goldman GS, BoA BAC, and Morgan Stanley MS will have to significantly downsize and perhaps even shed entirely their principal investment businesses, including real estate funds.  Will the selling and spinning-off of real estate funds be a potential buying opportunity for existing investment managers?

There is speculation on the Street regarding what Morgan Stanley is going to do with MSREF (Morgan Stanley’s real estate investment business).  While the Morgan Stanley spokespeople insist that the company will not conduct an outright sale of MSREF, it is clear that the umbrella company will have to divest itself from the business somehow.  Net asset values of the MSREF funds could be down as much as 66% from the funds’ inception.  MSREF was one of the most aggressive buyers at the peak of valuation, and as such, has defaulted on numerous assets.  This could be the perfect opportunity for funds exclusively in the CRE investment business to pick up legacy assets at a discount.  Many real estate private equity funds expected to pick up property on the cheap through FDIC or bank auctions, which has not yet happened on a large scale.  I bet few PE firms expected legislative reform, not over-leverage, to be the catalyst that would ultimately present them with buying opportunities.

But I wonder if investment banks divesting from principal investment can deliver the massive price correction that our industry needs.  The sheer volume of assets that need to be disposed of is quite large.  But the supply of capital may be even larger.  Even though MSREF assets have lost as much as 66% in value, there’s a good chance buyers will end up paying a premium on what the assets are worth, just as buyers have done with FDIC disposals.  Moreover, if MSREF and others take the route of conducting cleverly constructed spin-offs, it is possible that assets will not be re-priced at all but simply shifted from one holding company to another.