Distressed Debt Investors Prefer Real Estate In 2011

Distressed debt investors will be looking to capitalize on rising
default rates for commercial real estate.

With risk-taking coming back to most markets, investors in the
riskiest asset classes are being forced to channel their funds into
different sectors and instruments in their attempts to get the most
bang for their buck.

The North American Distressed Debt Market Outlook 2011, a survey of
100 experienced distressed debt investors released by Debtwire,
Macquarie Capital and Bingham McCutchen, found that these investors
will move their cash from energy to real estate assets and from first
and second-lien loans to common equity and convertible bonds.
Distressed debt investors will have to adapt to a surging equity
market and a bubble in high-yield loan markets, finding themselves
pushed down the capital structure in search for yield.

Distressed debt markets will provide opportunities for investors in
2011, as "lingering concerns about unemployment, housing, and the
European sovereign debt crisis will cause investors to remain cautious
and focus on the ability of companies to withstand additional economic
shock," according to David Miller of Macquarie Capital. Investors
will therefore "continue to stress the downside when evaluating
investment opportunities."

This will force a change in strategy for those brave enough to invest
in distressed assets. Real estate will be the sweet spot for investors
in 2011, with 48% of those surveyed choosing it as their favorite
sector, a 22% rise from a year ago.

Specifically, the sector will be commercial real estate, where 51% of
respondents expect default rates will not peak before the second half
of 2011. "[These findings] don't necessarily bode well for the
prospect of the housing and commercial real estate markets avoiding a
double dip," reads the report. (Read _Home Prices Double-Dipping
Before Spring_).

This represents a marked change from a year ago, when energy and
automotive sectors were amongst the top picks, with 37% and 29%
respectively. But, with energy prices back on the rise and "the
automotive sector dodging a huge bullet," opportunities will lay
elsewhere, in the real estate and financial markets. For example,
General Motors and Fords carry a Fitch corporate rating of BB-, which
is below investment grade. (Read Steve Schaefer's piece on investing
in GM and Ford, _Going Long GM_).

The change is not only in sector, but in preferred instrument too.
Whereas first and second-lien loans topped the list of "most
attractive opportunities" in 2010, common shares, convertible bonds,
and preferred/mezzanine loans have taken the top three spots. "There
is no longer a need to be at the top of the capital structure," said
Ronald Silverman of Bingham McCutchen, another of the firms that
cooperated in the report. "Unlike last year where first- and
second-lien loans were the place to be, fund managers are prepared to
move away from secured debt and are ready to enter on the ground

A bubble in the high-yield and leveraged loan markets, as well as the
staggering rebound in the equity markets, is the catalyst behind
change. "Many investors experienced significant gains as they
exploited inefficiencies in the high-yield and leveraged loan markets
in 2010. As investors continue to deploy capital to these markets,
returns will diminish, causing investors to move even further down the
capital structure in search of outsized yields," wrote Raoul Nowitz
of Macquarie. Thus, 55% of respondents see those markets in a bubble,
with most expecting a burst in the second half of 2011 or the early

Allocation of assets to distressed debt will remain essentially
unchanged from 2010, with distressed allocations exceeding 40% of
assets under management for 27% of those surveyed. Expected returns
are "largely in line with those of 2010," with 27% of managers
expecting returns under 5%, and 16% of them expecting returns greater
than 20%.

"Given the run-up in asset prices in 2010, distressed debt investors
will be forced to take more aggressive risk positions to chase higher
yields, creating an environment in which achieving extraordinary
returns will be increasingly challenging," said Ford Phillips of
Macquarie Capital.

Source: Forbes.com