Northstar Flexing Earnings Muscles; Window Closing on Others

by REIT Wrecks on August 7, 2008

I have already written extensively about Northstar here, here and here, among other places, so I will keep this somewhat short.

The biggest news to come out of the call from a “market” perspective is that Northstar is now starting to deploy cash. Forget about having to raise equity; they have $295 million available to invest. Also, in a further indication of credit quality (still no non-performers) they had $53 million in repayments during the quarter, and they estimate a possible $200 million in “optional” repayments for all of 2008. This means that their borrowers don’t have to repay, but they are choosing to do so because they are finding profitable exits, even in this terrible market

By extension, this also means that Northstar’s self-origination model is performing much better than the “whale” strategy employed by some other REITs: Raise a bunch of cash, and then cruise down Wall Street with your mouth open, collecting loans like so much plankton and krill.

Northstar was much more selective, and they did sacrifice short term earnings as a consequence (all that low yielding cash did nothing for their dividend). However, as things begin to play out, and assuming they maintain their incredible credit discipline, the forward dividend will start looking stronger and stronger.

Why? Because they have cash to deploy now. There are 36 private equity mezzanine funds on the road now, attempting to raise $21.3 billion. 2008 will see a huge increase in the number of these funds and their buying power. We’re only half way through the year, and already 14 mezzanine funds have raised $20.3 billion, vs. 29 funds that raised $15.7 billion for all of 2007. You can read the full story here, and a related story here.

These are not all real estate-focused funds, but the distress in this area is no secret, and plenty of them will be focusing on deals like the one that landed in my inbox just this morning: a discounted $231 million commercial and mezzanine loan portfolio with office and multifamily collateral located in New York and Chicago.

This is Northstar’s bread and butter, and they are clearly trying to get out ahead of the crowd (the article above notes that prices are already starting to increase). Accordingly, they expect to reduce available liquidity to between $50 and $100 million by the fourth quarter. Based on their available cash and estimated loan repayments, that may mean $400-$500 million of equity invested by year end. They think these investments will generate levered returns in excess of 20%.

With the new players rushing into this market, Northstar is betting that opportunities will start to decline in quantity and quality in 2009 and 2010. It’s too early to tell, but unless they can raise cash, this may mean that many of the more broken REITs will simply be left to manage run-off on legacy portfolios (or be wound up, acquired, etc).

There was some interesting “Itolja so” as well. Northstar did in fact buy back some of it’s own highly rated CDO debt at a 40% discount to face. As the CEO said, this validates the FAS 159 accounting model, and they booked a $7 million gain on the repurchase. It will be interesting to see how many other REITs choose to take advantage of the same dislocation. Click here for an updated list of Mortgage REITS”, including current yields.

REIT Investments

Disclosure: At the time of this writing, long NRF

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