GLOBAL - ING Real Estate this week sold the ING Entertainment Fund to one of its shareholders after deciding the likeliest alternative - a fire sale of assets - would not be in shareholders' best interests. Chairman Michael Coleman ruled out a fire sale after concluding with the fund's other directors that the time it would take to bring the assets to market would expose them unduly to market pricing risk. In other words, once potential buyers knew the fund had to sell, they would offer bargain basement prices.

It mirrors a similar phenomenon playing out within the European banking industry. Despite ongoing post-crisis rumours that banks would flood the market with distressed real estate assets, they have barely begun to purge their balance sheets. Lloyds Banking Group recently avoided a fire sale via 'consensual' working out of property loans that are in some cases greater than the value of the asset itself.

Banks are stubbornly valuing assets above what buyers might be willing to pay. Santander's €3bn asking price for a portfolio of 12,000 repossessed - and mainly secondary - residential units is a case in point.

Despite the continuing pricing disconnect between banks and buyers, some would-be distress investors believe the sovereign debt crisis might at last force the issue. Barry Sternlicht, chief executive of US property firm Starwood Capital, last month forecast a veritable conflagration of commercial assets as a result of Europe's imminent sovereign implosion. In a session on opportunities for real estate investors in capital markets, he told a conference hosted by New York University's Schack Institute of Real Estate there would be "tons of stuff for sale".

The big problem with opportunistic investment in distressed real estate is the intensive asset management that comes with it. Aberdeen Asset Management took on two distressed Nordic portfolios in March: a €537m Nordic portfolio previously managed by Danish asset manager Property Group, and a €300m Danish-owned portfolio in Sweden. Tonny Nielsen, head of Aberdeen Asset Management Denmark, says it would be a mistake to underestimate the kind of resources you need just to bring what are usually chaotic portfolios into some kind of order.
 
"You need to sell or re-let," he says. "Because fees are factored into that, it's a good business but often assets have been mismanaged and you have to get order into the chaos you're taking over. You can't sell anything chaotic - but you need steadily to divest mature properties."

It took six months to shake out the Swedish portfolio, to assess capital expenditure and come up with a maintenance plan. "As a group, we have the in-house resources to restructure, re-let, and divest or mature portfolios," says Nielsen. "We have 300 people handling these portfolios. You need to have the skills and resources to take it on. At its peak, one of the portfolios had 20 people completely involved in it."

This is one reason why indirect investors are opting for the simplest possible structures with niche strategies, according to Saul Goldstein, co-founder of Activum, which repositions 'undervalued' - or distressed - German real estate.

"We tend to focus on simply buying assets that require an operational turnaround," he says, adding that institutional investors "like our simple approach to the business both from the fund structure and the operational side".

If there are to be fire sales, there are a couple more things to consider. The first is that large portfolios will become interesting when a more active market creates bulk-to-retail discounts - and it has not happened yet. The second is that a fire sale would effectively force writedowns - hence banks' reluctance to agree to them.

According to Goldstein, they are more likely to sell only high quality assets and continue to drip non-performing and sub-performing real estate onto the market "in a very ad hoc way". Notably, his firm takes on properties in major cities with long-term prospects, and Berlin residential.

In the meantime, no amount of hype, cajoling or perhaps even discounting will be able to shift secondary assets. That is, at least until the market for secondary picks up and that, according to Invesco and other investment houses, could take a couple of years.
 

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