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By Margie Manning
ST. PETERSBURG — Directed Capital Resources has found a sweet spot in the soured commercial real estate market.
The private equity firm, which buys, manages and resolves distressed commercial mortgages, just wrapped up a $50 million capital raise. It will combine that funding from investors with borrowed money from Goldman Sachs Group Inc. to acquire as many as 250 loans over the next three years, said Christopher Moench, CEO.
Distressed debt is viewed as a growth area for workout firms such as Directed Capital. About $1.725 trillion of commercial real estate mortgages are slated to mature between now and 2016, and about 65 percent of them are underwater, or have a loan-to-value ratio of more than 100 percent, said Brad Salzer, principal at MacDill Capital Partners LLC, a Tampa investment firm that also focuses on commercial mortgage debt.
Although commercial property values have begun to stabilize after sharp writedowns from 2009 to 2011, most properties are not expected to regain pre-recession values for years. That could make it difficult for many owners to refinance when their loan comes due because the lender – often a bank under pressure from regulators to shore up its balance sheet – won’t want to hold potential problem loans on its books.
The commercial mortgage backed securities sector is another factor. CMBS origination volume spiked in 2003-2006, with most of the loans on a 10-year term basis. They also are coming to maturity and will have to refinanced.
“Interest rates have been low enough that borrowers could continue to make the payments, but the situation has to be resolved as the loan comes to maturity,” Moench said.
Directed Capital buys notes and loans typically ranging from $1 million to $5 million at a discount, then works with the borrower to get them back on track and to overcome whatever difficulties they are experiencing.
“When we deploy capital into an investment, we work to make sure it has good fundamentals so it can be successful,” Moench said. “We focus on the value of the underlying collateral and the credit characteristics of the borrower.”
The business model appeals to investors.
Since Directed Capital was founded in 2001, Moench and his partners have raised more than $135 million in equity in five funds and acquired more than $625 million in assets. Net returns to investors have been 16 percent to 18 percent a year, on average, Moench said.
DCR Mortgage Partners VI LP, the sixth fund, is the largest to date. It launched in January, with a goal of raising $49 million, according to a filing with the U.S. Securities and Exchange Commission. By the time fundraising concluded Sept. 28, it was slightly oversubscribed, Moench said.
The equity is paired with debt. Directed Capital had a prior lending relationship with Wells Fargo & Co. Goldman provided $34 million to pay off Wells, as well as an initial $50 million credit facility, with the right to expand that by $20 million.
About $20 million in capital from DCR Mortgage Partners VI already has been deployed. Directed Capital operates nationwide, but 40 percent to 50 percent of its holdings are in the southeast United States, Moench said. “We’re not buying large office buildings, so we’re not in downtown central business districts of Chicago or New York.”
Goodbye and hello
Directed Capital keeps all its work in-house. Its 18 employees in St. Petersburg and two in San Diego evaluate collateral, underwrite the deals and service the loans the firm purchases. A lot of analysis goes into each note purchase.
“Typically Directed Capital will look at 10 notes, bid on five of them and purchase one,” Moench said. “We’re not trying to hit home runs. We’re looking for singles and doubles. We’re not trying to take outsized risk. We’re trying to deploy our investors’ capital into a situation where the value of the collateral exceeds what we paid to buy the note. We’re trying to right-size the loan to value relationship.”
The note-trading business is a bit alien to most people, Salzer said. “Commercial mortgage notes are not traded like a stock but they are traded and the borrowers often don’t know their debt is being sold,” Salzer said. “They get a goodbye letter from the former lender and a hello letter from the new lender and the game is changed.
“Or maybe not. We have to honor the agreement but to the extent [the note] has defaulted or is nonperforming, then you have the opportunity to restructure it.”
MacDill Capital Partners concentrates on the southeast United States and along the East Coast. It’s not as large as Directed Capital, Salzer said, and is more willing to do deals that are “outside the box,” such as land deals.