Cash is king amid credit crunch

As the credit crunch makes loans harder to get for real estate investors, private property investment firms that get their funding from pension funds and other wealthy investors have found themselves in a stronger competitive position.

"Cash is king," said Arthur Pasquarella, chief financial officer of BPG Properties in Philadelphia. Last July, as banks began writing down billions in overpriced mortgage debt and turning off the credit tap that had inflated property markets in recent years, BPG collected $850 million in new cash from the Pennsylvania State Employees' Retirement System and corporate, insurance, university and foundation investors.

Last week the group finished its latest purchase: a buyout of publicly traded Boston Capital Real Estate Investment Trust for $260 million. The deal makes BPG a player in Seattle, Portland and other Northwestern markets, adding to nearly $5 billion in properties BPG owns in the Northeast, the Midwest and the Sunbelt states.

Even as banks like Citigroup and Deutsche Bank write off tens of billions in mortgage investment losses, equity investors such as pension systems have committed billions to new commercial real estate investments, said Michael Hines, head of the institutional group at broker CB Richard Ellis's Philadelphia office.

BPG is known locally as the developer of the Four Falls corporate center in West Conshohocken, and a redeveloper of apartment complexes such as Willowyck on Sumneytown Pike in Upper Gwynedd, Montgomery County.

The firm has more than doubled its portfolio, to 51 million square feet, since 2000. Growth continued after Pasquarella, chief executive Dan DiLella, and other BPG executives bought control of the firm from BPG Property Group in 2004. BPG still owns 25 percent of the company.

"The current environment plays to their strengths," said Robert Fahey, executive vice president at commercial property broker CB Richard Ellis in Philadelphia.

"A year ago, nine months ago, you could buy a piece of real estate and pretty easily arrange a loan for up to 85 percent of the purchase price. That permitted lots of private entrepreneurial types and less-well-capitalized investment funds to buy bigger and fancier assets.

"Now, with the global repricing of risk, you're limited to maybe 70 percent," Fahey added. "Someone like BPG who just raised almost a billion dollars of equity - that goes right into their hands. They're unique in that respect, certainly among their locally based competitors."

The credit crunch hasn't benefited all private equity strategies. To the contrary, it has cleared out buyers that firms such as Blackstone L.P. depend upon to flip properties and make a quick buck, said Scott Hastings, real estate investment trust (REIT) analyst at Delaware Investments in Philadelphia, which manages more than $150 billion in bond and stock investments.

Cheap money and low down payments allowed private equity firms to bid property prices higher from 2005 to early 2007, said Hastings.

"That world has changed. Inexpensive, easily accessible debt and high leverage are no longer so prevalent," he said. That should help not only cash-rich funds like BPG, but also conservatively run REITs, he added.

Just last winter, New York's Macklowe Properties bought $7 billion worth of office properties from Blackstone with just $50 million down, the rest borrowed from Deutsche Bank and other lenders. That deal couldn't happen today, Hastings said.

"We do not expect the same frenzied transaction market that existed in the past few years," he said. "The number of potential bidders for property will be reduced."

Nationally, office-building sales plunged 70 percent in October compared with a year earlier, according to Real Capital Analytics in New York. Other property sectors are also down. But rents and vacancies haven't fallen, and sale prices haven't plunged, as investors wait to see where the market will settle.

In the Philadelphia area, 2007 commercial real estate transactions totaled $4.3 billion, down slightly from $4.4 billion in each of the two previous years. A drop in office and industrial deals from 2006 levels was nearly offset by increases in retail, apartment and hotel transactions in the region, according to Dan Fasulo, managing director for research Real Capital Analytics in New York.

Retail investors are worried, however, by the threat posed by financial difficulties at highly leveraged investors like Australia-based Centro Properties Group, the fifth-largest U.S. shopping center owner.

Centro is seeking new investors after it failed to profitably refinance its portfolio of 700 U.S. retail centers, including Northeast Philadelphia's Roosevelt Mall and locations in Newtown, Marlton, Doylestown, Bristol, Cinnaminson, and other Philadelphia suburbs. That raised fears Centro would have to sell the properties.

"Who could finance that deal? The market is terrible," said Edward A. Glickman, president and chief operating officer of Pennsylvania Real Estate Investment Trust (PREIT), which owns larger malls in the Philadelphia area and other markets. "Banks don't want to own all those shopping centers."

Centro spokeswoman Stacy Slater said the firm wants to find investors for its entire U.S. portfolio, and wants to avoid selling properties piecemeal, which could depress prices in local markets.

Uncertainty over what will happen at Centro and other indebted investors has Wall Street worried about prospects even for solvent real estate players. REIT stocks lost a third of their value last year.

"Markets have been frozen," said Delaware's Hastings. Even solvent investors "have been sitting on the sidelines. They're waiting for prices to bottom. When they do, the better capitalized companies will definitely be able to take advantage of the situation."

Without public investors, BPG can afford some patience. "In the past few years, a lot of people bought a lot of property with virtually no money down," said Pasquarella. "We now have the discretionary equity to make deals happen."