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PCCP Rides Troubled Lehman Funds Acquisition to National Prominence

William Lindsay's California Firm Pivots from Value-Added Property Acquisitions to Today's Hottest Investment -- Distressed Commercial Mortgage Debt
March 31, 2010
William R. Lindsay, Founder of PCCP, LLC (formerly Pacific Coast Capital Partners)
William R. Lindsay, Founder of PCCP, LLC (formerly Pacific Coast Capital Partners)
Following a 13-month competitive bidding process, PCCP, LLC recently took over two Lehman Bros. private-equity mezzanine funds with more than $2 billion in assets. The transaction involving the collapsed New York investment house instantly made the California-based real estate investment firm a coast-to-coast player.

William R. Lindsay co-founded PCCP, LLC in 1998 with partners Don Kuemmeler, Nicholas Colonna and Aaron Giovara. Formerly Pacific Coast Capital Partners, PCCP has closed about 400 originated transactions totaling about $6.5 billion and has about $6 billion under management today. Transaction volume to date since its inception, including the Lehman positions, totals about $8.5 billion. PCCP manages four commingled funds of institutional investors, including banks, insurance companies and foundations, and five joint ventures with pension investors.

The Lehman Brothers Real Estate Mezzanine Partners I and II funds were formed in 2005 and 2007. PCCP renamed the funds PCCP Mezzanine Recovery Partners I and II following the closing of the transaction in December and opened a nine-person office in New York on Park Avenue. CoStar Advisor caught up with Lindsay recently to chat about the Lehman transaction and PCCP's strategies for doing business in today's torpid debt and equity markets.

Prior to forming PCCP, Lindsay was co-head of the real estate department of Gibson, Dunn & Crutcher, one of the nation's largest law firms. In 1986 and 1987, he served as a law clerk to former U.S. Supreme Court Chief Justice William H. Rehnquist.

Without commenting specifically on the Lehman collapse and bankruptcy, (read an account here by CoStar's Mark Heschmeyer on the CRE aspect of the Lehman downfall) Lindsay said that by a wide margin, the financial devastation resulting from the collapse of the big investment firms far outweighs the opportunities available to investors to date.

"The crisis we're in today has hurt a lot more people than the amount of opportunity it has presented so far," he said. "I expect the opportunities to increase over time, but the $64,000 question is when, and how fast."

PCCP has been in the debt and equity business since its 1998 inception. It's fairly unique for a private equity platform to both make real estate loans and invest in real estate equity, Lindsay says. PCCP focused on value-add acquisitions during the boom years of the mid-2000s. The plunge in property values from their 2007 highs, however, has prompted the firm to shift its strategy toward acquiring commercial real estate debt.

"We've always focused on the part of the market where capital is less available. During the [real estate pricing] bubble, that meant we had to have something a little more interesting in structure, so we ended up pursuing a lot of value-added properties.

"Today, the 'value add' is largely in showing up with the money, and being creative about the future business plan of the property. With equity wiped out, almost everyone would agree that the opportunity is in distressed real estate loans now."

The Lehman portfolio was one of the most prominent and extensive workouts going on in the real estate business, "and we felt we should be involved," Lindsay said.

"The reasoning was pretty simple: it's a big workout job, investors need help, and you can never go wrong helping investors," he said. "A pool of loans which presents a series of workout opportunities and the actual replacement of the [general partnership] is itself a value add."

PCCP submitted its bid in November 2008 to take over the Lehman mezzanine funds, and closed the deal in December 2009. The transaction opened up a number of new investor relationships PCCP had sought for years.

"It's a win for everybody involved. It's a win for the Lehman estate and the LPs -- they got a new manager that they like -- and the LPs have removed these funds from their 'issues list'. And we got a job that we know how to do, and that we can add value to."

The Lehman mezz loans are backed by properties across the U.S. and Europe, including the Hard Rock Hotel and Casino in Las Vegas, the LA Live entertainment and hotel complex in downtown Los Angeles near Staples Center, and an investment in the Kerzner International hotel portfolio. among other marquee assets.

Properties in the portfolio include office, apartments, not too much retail, and some condominiums. Interestingly, improving consumer confidence appears to be driving activity and firming up pricing on the condo properties, even in the embattled South Florida condo market, he said.

"The critical thing is, the mortgage market now exists. For a while, you couldn't get a mortgage even if you had a perfect credit score. Today, we're seeing that if the price is right, you can close it, even for jumbo mortgages."

In 2006, roughly 40% of PCCP's transactions were equity investments. Last year, by contrast, the firm closed two bankruptcy auction deals, one FDIC loan purchase and the Lehman mezz loan acquisition. Debt acquisition continues in 2010, with PCCP closing or committing on three transactions so far.

One of this year's deals involves the discounted acquisition of an asset from a financial institution and a well-known investment fund, Lindsay said. In another deal, PCCP is under contract to purchase a loan at a discount from a bank syndicate.

"We manufactured that deal -- went to the banks directly and proposed the purchase ourselves. The value add will be actually consummating the deal at a discount and owning it going forward, with a more flexible business plan.

"We're now focused on acquiring positions where the value add is the workout itself, or providing senior capital for those deals where someone is taking a loss and the capital stack is being stabilized."

PCCP is still interested in bidding at bankruptcy auctions. And a couple more "rescue and stabilization" deals like Lehman Bros. could materialize. In general, however, "2010 will be a reflection of 2009, with a little more flow," Lindsay said.

He said any FDIC loan purchases would have to be of sufficient scale to make sense from an efficiency and underwriting standpoint. To date, with the exception of the $5 billion Corus portfolio purchased by Starwood Capital, the average asset values of those loans has been fairly low.

That will likely change this year, however. Loan portfolios from banks that the FDIC took over last year will be hitting the market in coming months, with "more meaningful" average assets of $10 million or greater, Lindsay predicts. That's when the bidding will become intense.

"There will be a lot of competition among buyers because it's more efficient and you can underwrite more of the assets -- versus [for example] when you have a thousand loans with a $1 million average balance. As portfolios come to the marketplace with more sizable loans, we'll look at that. I would say, though, that I expect those FDIC auctions to be highly competitive."

How will the increase in troubled FDIC and bank loans and properties affect the marketplace?

"It's an interesting question. We see the money center banks which have earnings being a little more proactive in their existing portfolios. Some assets are coming to market. Property pricing is pretty buoyant right now; I think the banks know this and they're going to move assets to market because they're worth $10 to $50 per foot more than they thought. So, why not get it off the balance sheet as fast as possible?"

While there's a lot of capital on the sidelines today, the macro question is whether there's enough to fully recapitalize the ailing real estate business. At this point, Lindsay doesn't think so.

"If there's not, at some point prices must fall. That doesn't mean investors won't be smart enough to figure out there's an opportunity. But right now, it still seems like there's a lot of capital chasing very few deals."
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