Morgan Stanley Loses Properties to Itself and John Paulson Investment Consortium

Jan.12.11 | About: Morgan Stanley (MS)

A while back, I posted a piece aptly named “Doesn’t Morgan Stanley Read My Blog?”, wherein I lamented the fact that I made very clear in 2007 that anyone who bought the Sam Zell/Blackstone flips were guaranteed to lose money. It was literally etched in stone for anyone with an objective view and a calculator. I actually believe it was a miracle that Blackstone (NYSE:BX) didn’t lose their shirt. Well, guess who bought those buildings on behalf of their clients as they raked in the fees (see Wall Street Real Estate Funds Lose Between 61% to 98% for Their Investors as They Rake in Fees!)? You guessed it. None other than Morgan Stanley (NYSE:MS). This purchase was a 100% equity loss. The entire client fund apparently lost about 61% of the shareholder’s money. See this WSJ article: Morgan Stanley Property Fund Faces $5.4 Billion Loss.

Well, Morgan Stanley’s profitable (from a fee perspective) Real Estate division is in the news again. Bloomberg reports, Paulson Group Said to Seize Some CNL Hotels From Morgan Stanley:

A lender group including Paulson & Co., the New York-based hedge fund run by John Paulson, seized control of former CNL Hotels & Resorts Inc. properties from Morgan Stanley’s real estate funds through a $600 million debt restructuring, said two people with knowledge of the deal.

The transaction involves the corporate debt used to finance Morgan Stanley’s 2007 acquisition of the hotel owner near the peak of the real estate market. Under the terms of the restructuring, $200 million of corporate debt was extinguished and $400 million was converted into equity, said the people, who asked not to be identified because the information is private.

In addition to Paulson, the lenders are Winthrop Realty Trust, Capital Trust Inc. and Morgan Stanley’s special property group, according to the people.

In The Conundrum of Commercial Real Estate Stocks: In a CRE “Near Depression”, Why Are REIT Shares Still So High and Which Ones to Short?, I illustrated, in full detail, the reasons why I believe CRE is apparently floating in mid air, among them were:

  1. Conflict of Interest Number 1: The Managers of CRE Investment Funds Are Paid to Do Deals, Not Necessarily to Make Their Investors Money. (I offered readers a downloadable model that clearly delineates the free put option that makes fee generation trump performance incentives).
  2. Conflict of Interest Number 2: Those Banks That Are Selling and Recommending REIT Securities and CRE Investments Are The Same Banks That Got In Trouble Holding Said (Underperforming and Underwater) Securities and Needed to Dump Them On Naive Investors.

These funds did very well during the boom, but when the obvious bust came (and I blogged about it in full detail, so no one could say they didn’t see it coming), these funds crashed. Professional asset managers should know better. They are simply delivering leveraged market beta, not alpha. Investors are paying a fortune in fees to ride the mortgaged ups and downs of the real estate market.

Here’s another tidbit of information. Some of the banks that sponsored these investment funds also helped arrange the financing of the buildings that the funds bought. Without discussing the wide implications of this potential and actual conflict of interest, it remains to be said that if the building goes underwater, the lenders (which were often the banks) were underwater on the deals as well. The banks were underwater obviously need to get out from under these securities. What’s the easiest way to do that? Upgrade the sector and sell them to suckers, that’s how.

As stated Reggie Middleton vs Goldman Sachs, part 1, For Those Who Chose Not To Heed My Warning About Buying Products From Name Brand Wall Street Banks, and “Blog vs. Broker, whom do you trust!”, Goldman’s peddling of products often spells doom for the consumer (client) and bonus for the producer (Goldman). Goldman (NYSE:GS) is now underwriting CMBS under a broad fund our $19 billion bonus pool “buy” recommendation in the CRE REIT space reference Reggie Middleton Personally Congratulates Goldman, but Questions How Much More Can Be Pulled Off. Now, after all of the evidence that I have presented against the CRE space, who do you think would be better for clients' net worth, Reggie’s BoomBustBlog or Goldman?

The number one bulleted point above, hopefully, I have made obvious to most by now. Bulleted point number two is illustrated right in the Bloomberg article. You see, Morgan Stanley created a leveraged CRE fund and sold it to clients (pension funds, HNWs and foreigners) in such a fashion as to profit no matter how the market performed despite the fact the market was in an obvious bubble. Morgan Stanley also loaned its own client fund the monies to buy into the bubble. When the sh*t hit the fan and Morgan Stanley’s actual balance sheet was threatened (as opposed to their client’s balance sheets), they foreclosed on the client’s fund properties. What couldn’t be salvaged was upgraded (as in the REIT sector) as a buy in order to create the room to sell CMBS and dump the trash that the banks didn’t want on unsuspecting advisory clients (again, when will we learn our lessons). Now, back to the Bloomberg article.

The restructuring, completed Jan. 6, gave the group control of eight luxury resorts, one of the people said. Morgan Stanley’s real estate funds have the right to participate in future capital raising, they said.

… Morgan Stanley has suffered losses from its real estate funds after the credit crisis pummeled property values and soured deals made at peak prices. The company bought CNL Hotels in 2007 [the tippy top of the CRE bubble, with Morgan Stanley leveraged client monies.] for about $6.7 billion, adding luxury resorts including the Grand Wailea Resort Hotel & Spa in Maui; La Quinta Resort & Club and PGA West in La Quinta, California; and the Arizona Biltmore Resort & Spa in Phoenix.

… Morgan Stanley booked about $4.4 billion in real estate losses in 2008 and 2009. In November 2009, Morgan Stanley agreed to hand over Crescent Real Estate Equities to Barclays Capital, ending its obligation on a $2 billion loan.

… One of the firm’s property funds defaulted in July 2009 on a $192.5 million mortgage on the Maui Prince Hotel in Hawaii, prompting Wells Fargo & Co. to foreclose. The fund bought the golf resort with a Hawaiian developer for $575 million in 2007.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.