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Funds Cite CMBS Top Bet After Subprime Gains

FEB 12, 2013 1:16pm ET
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Hedge funds seeking the hottest trade of 2013 are turning to skyscrapers, shopping malls and hotels after last year’s rebound in residential real estate drove the industry’s best gains.

Boaz Weinstein, founder of Saba Capital Management LP, and Tom Kempner of Davidson Kempner Capital Management LLC cited commercial property bonds as their best investment idea last week at the EnTrust Investment Summit in New York, according to a person who attended and asked not to be named because it was a private event. Jamie Dinan, founder of York Capital Management LP, also speaking at the conference in the Waldorf Astoria Hotel, said his top pick is commercial property and stocks.

Firms are mainly investing in the $550 billion commercial mortgage backed securities market after the hedge-fund industry reaped its biggest gains last year on bets tied to subprime-home loans.

Firms are mainly investing in the $550 billion commercial mortgage backed securities market after the hedge-fund industry reaped its biggest gains last year on bets tied to subprime-home loans.

The managers, who can buy everything from corporate loans to stocks and derivatives, are joining mortgage-bond investors including Seer Capital Management LP and LibreMax Capital LLC touting commercial real estate after property values recovered 45% since bottoming in December 2009. Firms are mainly investing in the $550 billion commercial mortgage backed securities market after the hedge-fund industry reaped its biggest gains last year on bets tied to subprime-home loans.

“The fundamentals in CMBS have very slowly been repairing itself over the past three to four years, yet residential real estate received so much focus last year because finally after six years the housing market bottomed out,” Philip Weingord, chief executive officer of Seer, said last week in a Bloomberg Television interview. “CMBS underperformed many of the other sectors last year from a price perspective, but actually performed quite well from a fundamental credit perspective.”

Home-loan bonds without government backing returned an average of about 21% last year, according to Amherst Securities Group LP, with some notes tied to subprime borrowers rising more than 40%. That compares with gains of 10% to 12% for commercial debt, suggesting “CMBS still has significant upside,” Seer wrote in a letter to investors last month.

The $1.7 billion New York-based fund, started in 2009, increased its holdings of commercial-mortgage bonds to 23.8% as of Dec. 31, from less than 15% in September, according to the letter.

Weinstein, the former co-head of global credit trading at Deutsche Bank AG, started Saba in 2009 to profit on price discrepancies between loans, bonds and derivatives and now manages $5.3 billion. Last year he wagered against the JPMorgan Chase & Co. trader who earned the nickname the London Whale because his outsized trades were distorting prices in a credit-derivative index.

He said last week at the EnTrust meeting that investors should buy commercial-mortgage securities and equities, while shorting, or betting on price declines, in a high-yield index. Saba rose 3.9% last month, according to a person familiar with the matter.

Jonathan Gasthalter, a spokesman for the New York-based fund, and Robert Siegfried, for $19 billion Davidson Kempner, declined to comment on the event. Mary Beth Grover, a spokeswoman for $14.8 billion York, also based in New York, declined to comment.

Investors are buying CMBS and commercial property as buildings in large cities such as New York and San Francisco lead gains in the U.S., according to Moody’s Investors Service. Norway’s sovereign-wealth fund, the world’s largest, said yesterday it agreed to purchase a 49.9% stake in five U.S. office properties from TIAA-CREF, its first real estate investment in the world’s largest economy.

Landlords are also finding it easier to stay current on mortgage payments. The delinquency rate on commercial mortgages packaged into securities fell 10 basis points to about 9% in December, according to Barclays Plc. The rate has been falling since reaching a record 9.7% in July when borrowers struggled to refinance maturing debt taken out during the market’s 2007 peak.

That’s helped drive new bond sales, which is a boon for borrowers with loans coming due as landlords are able to access financing to pay off debt on everything from Manhattan skyscrapers to strip malls in Texas. Issuance is forecast to increase by more than 50% from last year to as much as $70 billion in 2013, according to Credit Suisse Group AG. Banks arranged about $8.3 billion in new CMBS deals in January, the highest monthly volume since 2007, according to JPMorgan.

UBS AG and Barclays may sell a $1.5 billion deal later this week and Morgan Stanley is planning a $193 million offering backed by an office building in Los Angeles that houses Oprah Winfrey’s network.

“All signs point to continued expansion in the commercial real estate market,” JPMorgan analysts led by Ed Reardon said in a Feb. 8 report. “Financing conditions continue to drive the commercial real estate recovery.”

Managers chasing higher yields in the CMBS market may struggle to find bonds that meet their return hurdles after the recent rally, said Harris Trifon, a commercial-mortgage debt analyst at Deutsche Bank.

“For the sector to be an attractive trade over the remainder of 2013, there would have to be a meaningful retracement,” Trifon said in a telephone interview. “It’s increasingly difficult to believe the magnitude of future price appreciation will be in line” with previous performance, he said.

The pace that property values are increasing has also slowed in recent months, with prices climbing 0.4% in November, according to a Jan. 10 report. Commercial real estate values will probably be unchanged or down in some markets in 2013, according to the New York-based rating company.

“With many investors’ expectations becoming overly optimistic, we think the recent market pause is not only healthy, but also gives investors a chance to reassess their expectations,” Bank of America Corp. analysts led by Alan Todd said in a Feb. 8 report.

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