Values in Mauled Debt

The news about U.S. commercial real estate is grim ("Deep Trouble," Nov. 16, 2009). But distress can lead to opportunity. Michael Winer, manager of Third Avenue Real Estate Value Fund (TAREX) since its 1998 inception, has proved particularly adept at navigating chaotic environments and profiting from messy restructurings or bankruptcies. Associate Editor Amy Feldman spoke with Winer about strategies for capitalizing on battered real estate.

You recently had just 20% of assets in U.S. real estate stocks, your lowest level in 11 years. Don't you see any opportunities in commercial real estate?

It's tough to find great value in public securities in the U.S. commercial market. A lot of debt will be maturing over the next few years, and there's no clear picture of how this debt will get refinanced without new equity. Real estate investment trusts [REITs] have been reporting third-quarter results, and it's pretty ugly.

Yet you have stakes in a few U.S. real estate companies, including Forest City Enterprises (FCE.A), your top holding.

Forest City is a real estate operating company, not a REIT. We recently picked them up cheap. Long-term, we still like Forest City. We like their asset base and think their stock is cheap relative to net asset value. But I cannot say that for the vast majority of REITs. REITs are trading at 20% to 30% premiums to NAV. Six months ago they were at big discounts, but they've rallied and are now overpriced. REITs today trade at 17 times cash flow, higher than the historical average. And you have to think cash flow will be lower a year from now because leases will come up and renewals will occur at lower rates; at the same time, interest costs are going up. So they're getting squeezed from both sides. That's why we are so heavily invested outside the U.S. and why we like Asia.

Before we turn to Asia, tell me about the REITs you do own.

We own ProLogis (PLD), Vornado Realty Trust (VNO), and Kimco Realty Trust (KIM). [ProLogis is an industrial player, Vornado a commercial one, and Kimco's focus is shopping centers.] We bought ProLogis and Kimco when the stocks were cheap earlier this year. Vornado's been a long-term holding. It's one of the few REITs we believe will be able to capitalize on future distress in real estate.

Do you see other distressed plays?

We made several investments in distressed companies over the past year and a half, including Newhall Land Development [a private California company]. We bought about $100 million of senior secured debt at distressed prices and were involved in the reorganization. It came out of bankruptcy in July. We own about 10% of the reorganized company's equity. Last winter we also invested $100 million or so in the debt of several U.S. REITs that was trading at 40 cents to 60 cents on the dollar. That has rallied to 90 cents on the dollar or better. We also bought the bank debt of General Growth Properties (GGP) prior to its filing for bankruptcy. We bought it at 20 cents on the dollar, and it's trading at more than 80 cents on the dollar. One of our big advantages is we're not restricted to U.S. stocks. If I were managing a U.S. REIT fund, I'd be 75% in cash.

On Sept. 30 the fund had more than 25% of its assets in Asia. What's the appeal there?

We have our largest exposure—and have increased our exposure—in Hong Kong. Our two largest holdings there are Henderson Land Development (HLDCY) and Hang Lung Properties. They have incredibly strong financial positions. They do commercial development and residential for-sale projects. Hong Kong was in a cyclical downturn, but it snapped back and is now in the midst of a rally. We've always felt there was long-term benefit to having exposure to the growth of mainland China through Hong Kong companies. China is going to be a machine that's hard to stop.

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