China to the Rescue

For the past year, the fate of commercial real estate in the U.S. has been a popular talking point for economic bears. Something like $1.4 trillion in commercial real estate loans comes due in the next 3 years.   

 

Given that a good portion of these properties are underwater, and the fact that banks are still reluctant to lend, the concern that many of these loans won’t get refinancing seems valid.   

 

Already, we have seen companies simply walk away from properties that are losing money, turning the keys over to the banks that hold the mortgages. Maguire Properties (NYSE:MPG) has done it. And we’ve seen BlackRock (NYSE:BLK) and Tishman Speyer Properties abandon Manhattan’s Stuyvesant Tower when the value fell from $5.4 billion to $2 billion.  

 

For shareholders, these moves make sense because it’s better than throwing good money after bad. For Maguire, it was a matter of life or death for the company.   

 

Still, it’s a concern because someone has to step up and buy the impaired real estate from the banks. Otherwise, bank balance sheets are saddled with even more toxic assets, capital bases fall, lending dries up and the whole financial crisis gets repeated again.  

 

Interestingly, it may be the Chinese who help the U.S. out of this commercial real estate problem.   

 

General Growth Partners (NYSE:GGP) is the second largest mall owner in the U.S.  It owns over 200 of them. Obviously, malls are in bad shape. General Growth has 13 malls that are underwater and another 24 that are labeled “non-income producing.”   

 

A $44 stock in May of 2008, General Growth fell below $0.50 a share as it declared the largest property bankruptcy ever in the U.S. when it filed in April 2009.   

 

General Growth has managed to restructure $11.6 billion of $14.9 billion in property related debt and is reportedly close to a deal for another 24 loans totaling $1.5 billion. It’s trying to emerge from bankruptcy.  

 

There is value in General Growth’s assets. Simon Property Group (NYSE:SPG) recently offered $10 billion, or about $9 a share for General Growth. Not bad for a company that’s stock was under $1 a few months ago. Not bad, but also not good enough. One of General Growth’s biggest investors, Brookfield Asset Management (NYSE:BAM), has offered to purchase $2.63 billion in equity to help General Growth stave off the Simon bid and emerge from bankruptcy as a stand alone company. Pershing Square Management and Fairholme Capital Management (who run the Fairholme Fund (FAIRX) which is a core holding of my Recovery Portfolio) have pledged an additional $3.93 billion.   

 

The plan is for General Growth to raise additional funds, bringing the entire deal to $15 a share for General Growth. It’s clear that General Growth’s investors believe the company is worth more than the $9 a share that Simon Properties offered.   

 

So, what’s this got to do with China? Glad you asked…   

 

In 2009, Brookfield put together a $5.5 billion fund to buy impaired commercial real estate. The fund was dubbed “Real Estate Turnaround Consortium”. And one of the investors in this fund is none other that the China Investment Corp (CIC), the state-owned investment company that helps China invest its $2.4 trillion of foreign reserves.   

 

The CIC currently has $300 billion to invest. It’s reported that it may have made $10 billion last year. That’s pretty good, compared to the results of other sovereign wealth funds, like Dubai’s.   

 

So successful, in fact, that Reuters is reporting that China may give the CIC another $200 billion to manage.   

 

CIC recently filed its first ever 13-F form with the SEC. the 13-F is a disclosure form required of any investment with over $100 million in assets. The CIC’s biggest U.S. investments are $3.4 billion in Teck Resources (NYSE:TCK), $1.7 billion in Morgan Stanley (NYSE:MS) and $700 million in Blackrock (NYSE:BLK).   

 

The point here is not so much what the CIC is buying, but the fact that it is openly disclosing its holdings. That’s more transparency than we get from middle-eastern sovereign wealth funds, which don’t disclose their investments, but rather let their investment managers handle the disclosure, thereby masking who the ultimate investor is.   

 

I suspect that China is trying to play above board on their investments to avoid the issues that arose when it tried to buy Interoil a couple years ago, and also the political fallout when United Arab Emirates bought Dubai Ports World, which owned the British company that ran the Baltimore ports.   

 

Transparent filings may help China if it intends to invest in U.S. commercial real estate.   

 

China has recently pledged that it will continue to buy U.S. Treasuries, even though it knows the investments will likely lose money as the dollar depreciates.   

 

We also know that China wants to diversify investments. And like Japan in the 1980s, it’s easy to imagine that U.S. commercial real estate is a possible target.   

 

And so it could be, in fact I think it is highly likely, that the strength we’ve seen from Maguire Properties and other commercial real estate entities is related to growing interest from China.   

 

This will take a while to fully play out. And I will be watching any developments with interest. I’ll let you know what I find out…