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Highly Focused Fund Seeks $300 Million In Small-Cap Deals

November 06, 2012

Amid a distressed-asset investment arena still characterized by an over-abundance of capital relative to promising transactions, it's quite the challenge these days to avoid heavy competition while scouring growth-oriented markets for potentially lucrative deals.

So veteran income-property investment and finance pros Andrew Reiken, Donald Spalding and Paul Aiesi are pursuing a strategy likely of interest to quite a few MarketBeat readers: Think small and produce big returns.

The principals of Graycliff Capital Partners are now raising capital for their third commingled fund - dubbed Graycliff Capital CRE Value Add Fund - which is targeting opportunistic and value-add investments into smallish transactions requiring equity infusions generally in the range of $1 million to $5 million.

In addition to acquiring troubled small-balance assets from owners, lenders and special servicers, they'll work with small borrowers needing additional capital to get otherwise well-positioned properties performing optimally. And in many cases they'll team with smallish local experts well equipped to manage fund assets - and willing to make modest cash investments of their own.

The Graycliff team is mostly scouting out relatively small marketplaces where the big boys rarely roam - and which the fund's promotional materials characterize as "lesser-shopped." For instance much of the activity is likely to land in secondary markets within a short drive of the Southeast's so-called I-85 corridor: including but not limited to Montgomery on the south along with Birmingham, Savannah, Charleston, Columbia, Greenville-Spartanburg and Raleigh-Durham.

The Graycliff principals also like, and are quite familiar with, some of the second-tier metros conveniently linked via the Midwest's Interstate system: Indianapolis, Louisville, Cincinnati, Columbus, Pittsburgh - along with Madison and Chicagoland suburbs further north and west.

Not coincidentally all of these target markets are within a reasonable drive from either of the Graycliff team's two offices: in Greenville and the Chicago suburb of Northbrook. And if speedier transport is required, Aiesi has been a commercial pilot - and can presumably handle a (ahem) small plane.

As a small shop, Graycliff's principals aim to spend their days in these chosen markets, hand-picking the most promising assets as well as local operating partners (who might be asked to kick in maybe 10 to 20 percent of a given project's equity needs). As a loan originator at PNC/Midland, GE Real Estate and more recently the high-volume, small-balance-oriented former LaSalle Bank conduit lending operation, Spalding has extensive contacts with potential asset sellers including owners, lenders and servicers (and intermediaries as well).

The expectation is that these relationships will spawn a lot of off-market transactions for the fund managers - a seemingly sound strategy for avoiding profit-eroding competition. Reiken has a long background in property finance and investment (with LaSalle, Macquarie Holdings, Goldman Sachs), while Aiesi specializes in acquisitions, and asset management and dispositions.

All are also affiliated with real estate investment manager Poinsett Capital Advisors in Greenville, and as such have immediate access to expertise in strategic asset management planning, risk management and even property management and leasing services.

The principals and their placement agents cite sources including Real Capital Analytics, MIT Center For Real Estate, the Fed, the MBA and Deutsche Bank to support their contention that the coming half-decade or so holds great opportunity for expertly managed investments in small-balance commercial property assets.

Similar to return characteristics seen in the 1992-97 period in the wake of the S&L fiasco and formation of the Resolution Trust Corp. disposition clearinghouse, capital invested in 2012-17 should generate superior risk-adjusted investment opportunities.

And among some $1 trillion in mortgage maturities scheduled over coming four years are billions in seven-figure conduit loans originated and securitized during Wall Street's bubble years.

Compared to many of the distressed-asset funds raised in recent years, the CRE Value Add Fund (which principals refer to as their Fund III) is also on the small side. The equity-raise target is $75 million, which with leverage of up to 80 percent might potentially generate an investment capacity over the coming three years or more in the vicinity of $300 million.

That's clearly larger than the team's two previous funds - one purely focused on commercial mortgage-backed securities, the other (still in operation) taking a similar strategy recapitalizing and otherwise improving mostly distressed small-cap commercial and multi-housing properties (but on a shorter-term horizon).

One perhaps revealing example: Fund II through an all-cash transaction purchased the distressed note secured by a nearly half-vacant small shopping center in Hartsville, SC before executing a deed in lieu. With the fund's new investment basis at $62 a foot - 60 percent of estimated replacement cost - management secured three additional tenants boosting occupancy to 86 percent before re-selling at $75 a foot - and quickly generating a 20 percent IRR.

Now Fund III is targeting relatively large investors - or at least commitments, as the minimum equity contribution is $5 million. And the return target is sizable as well at IRRs in the high-teens (Fund II's average is expected to end up around 20 percent).

The principals promise to contribute at least 2 percent of the fund's equity (and likely more), along with an 8 percent pro-rata preferred return rate to investors. The managers are to receive 20 percent of the distributions beyond the preferred hurdle, along with a 1.5 percent annual management fee and a 1 percent investment transaction fee.

And again, the focus will be on transactions that aren't of much interest to heftier opportunists targeting sizable portfolios and/or individual investments requiring equity infusions of $10 million or more, according to the fund's descriptive materials (the principals aren't publicizing the fund with media interviews during the capital-raising period).

Management's thinking is that a lot of entities controlling smallish assets needing new capital just don't have access to new funds. These might include owners facing maturities of loan balances in excess of refinancing proceeds now available, and who might look to sell at a bargain price or need a financial partner to negotiate a favorable pay-off with lenders.

Or in some cases investors with reasonably performing properties might be looking to bring in a new capital partner to buy out distressed co-owners at attractive valuations. Others might simply be having trouble accessing debt and equity needed for capital improvements that could boost a property's financial performance substantially.

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