Annaly’s New Mortgage REIT Falls Short, While Lehman’s Limited Partners Cry Foul

It’s true; I was feeling a bit continental so I decided to take an entire month off from the world of REITs and commercial real estate. But Labor Day is no longer the summer sanctuary it once was. Not only does the holiday fall in September, preceding the month that has become known for Black Monday and the Crash of 1929, but September is now known as the month in which capitalism itself was nearly killed for good. It would have been hard to believe then, but the cynical attack on its iconic symbols eight years earlier is now even more poignant.

Nevertheless, Teddy Roosevelt implores us to get back in the arena, to strive valiantly, even through dust and sweat and blood and tears; to keep fighting even if we come up short. And that is exactly what Annaly did last week with the launch of its new commercial mortgage REIT, CreXus.

While CreXus did manage to raise $200 million to go shopping for distressed commercial mortgages, it had to cut the size of the offering by more than half, and even then it had to sell Annaly almost 30% of the deal in order to clear the market.

CreXus plans to use the proceeds to acquire commercial mortgage real estate related debt and other commercial real estate-related assets, and this was the problem. Buy side managers were not convinced that CreXus management knows its way around the CMBS market as well as Annaly management knows its way around the RMBS market, and several said they would rather wait for Tom Barrack’s new commercial Mortgage REIT to come next week, rather than invest in the unproven CreXus.

While avoiding buyer’s remorse may be the theme of the day with Mortgage REIT IPOs, creating it may be the intention of some limited partners in one of Lehman Brothers’ real estate private equity partnerships. Indeed, the sale of the remants of the Lehman’s real estate group to former management (including Mark Walsh who was “present at the creation”, shall we say) appears to be pretty much on rails.

However, citing “greed, fraud, hubris, deceit, gross mismanagement and disregard of fiduciary obligations”, a committee of limited partners in a real estate fund Walsh helped assemble is building what appears to be a fraudulent conveyance claim against Lehman and some of its affiliates, alleging that they used one of these partnerships to help eject toxic real estate assets from Lehman’s balance sheet in 2007.

The informal complaint, sent in an email to investors and the General Partner, cites Lehman’s “deceit in selling LP interests” to investors in LBREP III, including allegedly selling property to the partnership for $157 million more than Lehman paid for the same property just a few months earlier.

Both sides acknowledge that the investments are now worth about half the what LBREP III investors paid Lehman, and not surprisingly a large number of limiteds balked at a recent capital call to fund on-going expenses, including a retro-active increase in the management fee! Not only that, it appears that Lehman was charging management fees to its investors before they even owned the assets.

Although the email alleges “breach of fiduciary obligations”, astute observers will note that securities firms like Lehman have no such obligations. Lehman was simply obligated to determine “suitability”, which is a much different and much lower standard than a fiduciary standard.

In an oversimplified paragraph, if Lehman determines that it’s suitable to charge investors $157 million more for a pool of assets than Lehman paid, then so be it. Private equity is a caveat emptor world, and the investors in LBREP III may be about to learn an expensive lesson in Latin. CreXus investors on the other hand, by demanding that Annaly buy 30% of its own REIT, appear to be taking no such chances.