MSREF and other “opportunity funds” were among the many tantalizing investments sold by Wall Street to large institutions over the past five years. Opportunity funds are different from other real-estate funds in that they make extra use of borrowed money for purchases, sometimes more than 70% of the value of the properties, compared with about 50% for more traditional real-estate investments. The leverage makes it easier to produce higher profits if values rise. But if they fall, the decline can quickly wipe out equity.
For the fund managers, there was another benefit: Opportunity funds rewarded them with high fees and a cut of any increase in asset value. Across Wall Street, the value of the assets held by opportunity funds jumped from $134 billion at the end of 2005 to $280 billion at the end of 2007. Many of the buildings in the funds are now worth less than their mortgages. Even worse, some of them are no longer producing enough cash flow to service their debts, meaning the funds have to invest more or face foreclosure. Industry experts say write-downs in excess of 50% for 2008 will be typical.
And there’s this:
The appearance of dismal returns shows how steep losses sustained by the commercial real-estate industry are being absorbed by retired teachers, policemen and other beneficiaries of the institutions that were chasing the funds’ high returns. The looming losses will likely increase the pressure for higher taxes to shore up government-employee pensions and more cutbacks at universities and foundations.