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New Real Estate Hedge Funds Popping Up

Nicholas Yulico

Several notable names are in the midst of raising money for new real estate-focused hedge funds.

Two weeks ago, Jay Leupp, managing director of equity research at RBC Capital Markets, became the latest to jump into the space. Leupp, who has covered real estate investment trusts for more than 14 years, has taken his sell-side REIT team with him to launch a new long-short hedge fund called Alesco, sources say. The San Francisco-based fund is said to be in the process of raising money. Leupp couldn't be reached for comment.

Colony Capital, a firm headed by legendary real estate investor Tom Barrack, has been raising funds since last year for its hedge fund, according to people familiar with the situation. Colony is partnering with Saudi billionaire Prince Alwaleed bin Talal on the $3.9 billion buyout of Fairmont Hotels & Resorts(FHR Quote).

Most of the real estate-focused hedge funds that have started in recent years stemmed from long-only REIT investors deciding to add a long-short product, or from direct real estate investors in the private market, such as Colony Capital, opting to make trades with public real estate stocks. Transwestern Investment Co., a Chicago-based direct real estate investor that already offers a long-only real estate-securities product, says it is planning to offer a hedge fund vehicle later this year.

"There are many high-quality real estate investors moving into the real estate hedge fund space. We welcome their arrival, as it further validates the business model," says Michael Elrad, senior managing partner of GEM Realty Capital in Chicago, which has run a long-short real estate hedge fund for seven years. GEM also is a direct investor in properties.

While there is no definitive number on how many real estate hedge funds exist, Carl Tash, founder and CEO of Los Angeles-based Cliffwood Partners, says he's heard estimates that 30 to 40 are out there. Cliffwood is one of the oldest in the arena, having offered a long-short real estate hedge fund since 1994. The hedge fund has $100 million under management. Another $500 million is managed by Cliffwood under a long-only fund.

One of the deterrents of creating a real estate hedge fund is the difficulty of shorting REIT stocks. Any borrower of the shares has to cover the REIT's dividend once announced. As well, REITs have been on a remarkable run, beating the S&P 500 for the past five years. Therefore, shorting traditional REIT sectors like office, retail and apartments has been difficult, Tash says, whereas shorting residential-mortgage REITs has been profitable.

"In real estate, I'm not sure a lot of these managers have been tested yet, because we haven't had a serious bear market in six years," Tash says. Tash declined to provide his fund's performance, explaining that he might be prevented from raising money if he did.

While U.S. REITs that own properties continue to be the bull's-eye of investing activity in the space, hedge funds also are making bets on mortgage REITs, homebuilders, international REITs and C-Corps. Making plays on publicly traded real estate debt is a lesser focus.

While fund managers won't describe their specific hedging strategies, value investing is clearly a part of the long strategies. It's why a name like CarrAmerica (CRE Quote) popped up on several hedge funds' radar screens over the past year. Tash says he bought CarrAmerica because it was undervalued, and he believed good things were happening with the company, as its Northern California office portfolio was starting to rebound. On Monday, the REIT said it agreed to be bought by the Blackstone Group for $5.6 billion, or $44.75 a share. That price is 28% above where the stock stood at the beginning of the year.

CarrAmerica's third-largest owner is Wesley Capital Management, a New York-based real estate hedge fund. Art Wrubel, one of the Wesley managers, used to work with Tash in the late 1980s at JMB Realty, a longtime Chicago-based commercial real estate owner. Elrad, from GEM Realty, also worked at the firm.

Tash cautions that shorting purely on valuation is a "fool's game." Even though many sell-side analysts have been warning for some time that REITs are overvalued and due for a correction, the sector continues to go higher, proving all the doomsayers wrong. Even Leupp, the RBC analyst who is now raising money for his hedge fund, had predicted in early 2005 that REITs would end the year either flat or down 10%. Instead, the MSCI U.S. REIT Index rose more than 12%.

Tash says short opportunities still remain in residential-mortgage REITs, and counts homebuilders among event-driven shorts, based on some "negative clouds on housing."

Half of the holdings in Cliffwood's hedge fund are C-Corps rather than REITs. Tash decided over a year ago to limit his exposure to the REIT sector because of its growing volatility (partly due to macro hedge fund interest) and because he saw better value outside of REITs.

One of the firm's largest long positions is Intrawest (IDR Quote), a Canadian operator of golf and ski resorts. Last week, the company said it hired Goldman Sachs to review its strategic options, including cashing in on some of its lucrative real estate. The stock has since surged 11%.