Distressed Debt Investors Prefer Real Estate In 2011ForbesJanuary 27, 2011With 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.
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.
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 floor.
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 2012.
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.
I cannot wait to show you all the end result and hopefully this will happen very very soon. 
