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New Fund To Co-Invest With Under-Water Small-Balance Borrowers

April 19, 2010

With property values deflated and debt markets still skittish, no shortage of small-balance investors is having trouble refinancing full outstanding mortgage balances as loans come due.

Veteran property finance pros Jay Rollins and Maren Steinberg want to help at least some of them hold on to their assets - and earn a decent return for their capital, efforts and risks.

The principals of JCR Capital and their associates at the Denver finance outfit have just started deploying the $22 million (and counting) in equity funding the firm's JCR Capital Distressed & Opportunistic Real Estate Fund I.

The Rollins/Steinberg team isn't aiming to bang heads with so many other opportunistic investment managers looking to scoop up large distressed assets at bargain-basement pricing.

Instead, a key principle in the JCR fund's strategy essentially entails partnering with owners whose small commercial properties have sunk under water in leverage terms - and who face mortgage maturities they can't fully refinance.

These are the fund's preferred "911"-category clients, as Rollins likes to label them. And the preferred solution in these cases is for the JCR team to negotiate the best short sale arrangement it can with the noteholder.

The successor ownership entity would include the fund as "white knight" along with the current owner - who "lives to fight another day," as Rollins puts it.

Of course short sales aren't always viable, and the JCR team will also aim for wide-varying "creative restructuring" solutions, with the fund providing new capital at various tranches within the capital stack.

The infusions might take the form of straight or preferred equity, perhaps participating debt. The fund's stakes in ventures would often be in the range of 5 to 20 percent (more in some cases), depending on the owner's and property's particular situation.

"It's the Wild Wild West; everything's on the table," Rollins relates, adding that the fund's capital is targeting yields in the mid- to high-teens.

Individual transactions might include fund investments totaling as little as $500,000 if that's all a given solution requires. The collateral securing the fund's investments would typically be interests in the entity that owns the real estate.

Exit strategies, no more than three years out in most cases, will be identified before investments close. They might include another refinance if the partner has solid credit, or maybe a sale at an attractive return to a buyer with access to sufficient debt.

But Rollins stresses that exits will not be based on anticipated recovery of the commercial real estate finance markets. "We don't like 'cross-your-fingers' exits."

While an investment manager's underwriting costs can run nearly as high for a large transaction as a small-balance deal, the Rollins/Steinberg team aims to focus mostly on smallish ventures. They perceive superior liquidity in the small-balance arena, along with a wider array of potential capital and structural solutions.

"There are more places you can go with a $5 million deal than a $50 million deal," Rollins observes.

The JCR investment managers also aim to minimize those due diligence costs by encouraging prospective partners to present "pre-underwritten" deals proposing structures and capital stacks.

The fund managers are also looking to partner with "411"-type clients, i.e., buyers of distressed notes or other assets that don't have quite enough cash on hand to complete soon-to-close deals.

In fact the fund's first investment, slated to close in late-April, is a note purchase for which JCR provided debt amounting to 60 percent of the purchase price, along with equity on a pari passu basis with the partner.

Investors contributing a total of $17 million toward the fund's initial closing include JAM Equity Partners, which is affiliated with Jacobs Asset Management and is a part owner of JCR, as well as PartnerRe Capital Markets and Branzan Investment Advisors.

The JCR team provided $5 million in "entity level" equity. The principals are shooting for a total equity raise of $25 million to $30 million.

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