We bumped into Danny DeVito a fortnight ago in Berlin. The pocket-sized actor was in town for the Golden Camera awards, the German equivalent of the Oscars, where he was due to receive a well-deserved Lifetime Achievement accolade from his peers in the German movie business.
DeVito has been involved in numerous good movies as an actor, director and producer – but we’ll always remember his role as corporate raider and asset stripper Lawrence Garfield in the 1991 drama Other People’s Money. Engaged in a battle for control of struggling New England Wire and Cable with ‘old school’ businessman Gregory Peck as the company’s patriarch, the high point of the movie is when DeVito as Larry the Liquidator persuades the reluctant shareholders to take his money and run. Faced with the encroaching new technology of fibre optics and a share price in terminal decline, the shareholders finally succumb to Larry’s appeal to their pockets. “I’m not your best friend. I’m your ONLY friend. I’m making you money”, he explains to them.
Relaxing on the intercity train on the return trip to Frankfurt, it wasn’t long until our contemplations of DeVito and Schumpeterian notions of capitalism led naturally on to thinking about Morgan Stanley. Not just Morgan Stanley, of course. But they, and other blue chip custodians of global real estate who successfully helped to part armies of investors from those extra millions known as ‘the promote’. This is the premium paid by hopeful investors for the alpha returns they expect from Morgan Stanley, rather than just the beta returns offered by the market. The price you pay for the privilege of being parted from your money by the best, as it were.
If you’re Morgan Stanley, or Goldman Sachs, or Fortress, or any other high priest at managing Other People’s Money, it’s that extra layer of income, your gilt-edged, downside-hedged, honey-lined guarantee that makes it all worth while – should it turn out that you’re no better at investing in real estate than anybody else, heaven forbid.
Three years ago, Morgan Stanley was the biggest single buyer of German commercial real estate in the entire country. The investment bank spent over €10bn in 2007, swooping in to scoop up Germany’s most visible and prestigious office buildings, partnering in syndications and joint ventures, teaming up with asset managers to profit across the whole value chain – and to enlighten the slow-witted Germans, who just didn’t seem to ‘get it’ – that is, ‘get’ the whole real estate thing. In one of the last of the big deals before the crisis hit home heavily, Morgan Stanley paid €2.1 billion for the ‘Pegasus’ portfolio from fund manager Union Investment – presumably one of those German investors who ‘didn’t get it’. (It’s maybe a good thing they didn’t, as it’s helped Union Investment become the largest cross-border investor in Europe over the past twelve months.)
The Pegasus portfolio, including prestigious landmark buildings such as the Frankfurter Welle and the Neue Kranzler Eck in Berlin, was bought on a non-recourse basis using €1.9bn of borrowings from Royal Bank of Scotland, or about 90% leverage. With the securitisation markets about to collapse, RBS didn’t get a chance to bundle up and atomise the loan so that it could become Other People’s Problem. Unsurprisingly, it’s still RBS’s problem.
Over in the US, Morgan Stanley’s acquisition of Crescent Real Estate Equities in 2007 for $6.5 billion in cash proved a master-stroke of bad timing. Two years later, the deal, which included 54 office buildings in big cities across the US, ended with Morgan Stanley simply handing the company over to Barclays Capital, to avoid having to cover a $2bn loan obligation.
Here in Germany too, Morgan Stanley has been on the retreat for the past year, selling where it can, cancelling joint project development agreements, and scrutinising the small print on all its previous deals to see what its exit options are.
With the Pegasus Portfolio, the answer was clear – Jingle Mail, or simply sending the keys back to the lender and walking away. The unsuspecting British taxpayer, who owns RBS, has – mirabile dictu - become a major German landowner and is likely to remain so for quite a while.
In New York, investors Tishman Speyer and BlackRock also saw the writing on the wall when they walked away from their in vestment in the enormous Stuyvesant Town complex on the Lower East Side. Like Morgan Stanley, their investment was gone, and it became pointless to throw further good money after bad. The jig was up, any prospect of profits had flown the coop, the money was lost – forever. They just handed back the keys and walked away.
In the world inhabited by these Larry the Liquidators, the actions taken by these financial titans makes sense. They will hopefully live to fight another day by taking their (investors’) losses today, rather than succumbing to death by a thousand cuts – or paralysis and stagnation, as we’re currently witnessing in the real estate markets. Our biggest fear is the ongoing reluctance of investors, hanging on by their finger nails and the forbearance of their banks, to engage in the inevitable process of recognising their losses and committing to a clear exit strategy. It won’t happen overnight, but we’re seeing some signs in Germany that others are girding themselves to follow the Morgan Stanley/Tishman Speyer route, and abandon a lost cause. It needs to happen.
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