Morgan Stanley Property Fund Faces $5.4B Loss

¹²Morgan Stanley Property Fund Faces $5.4 Billion Loss

By Anton Troianovski and Lingling Wei | 15 April 2010

Morgan Stanley has told investors in its $8.8 billion real-estate fund that it may lose nearly two-thirds of its money from bum property investments, according to fund documents reviewed by The Wall Street Journal. That would likely make it the biggest dollar loss— $5.4 billion— in the history of private-equity real-estate investing. Over the past 20 years, Morgan Stanley's real-estate unit was one of the biggest buyers of property around the world, doing some $174 billion in deals since 1991, mostly with money raised from pension funds, college endowments and foreign investors. The losses come from investments in properties such as the European Central Bank's Frankfurt headquarters, a big development project in Tokyo and InterContinental hotels across Europe, among others.

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FRANKFURT EUROTOWER: Morgan Stanley projects losses of 90% on the fund's $77 million investment in the Eurotower, which is the headquarters of the European Central Bank.

The loss also represents a huge challenge for the firm as it tries to resuscitate its Morgan Stanley Real Estate Funds business, known as Msref. The firm has reinstated Owen Thomas, the executive who helped create Msref, as head of the real-estate business and brought in an outsider, real-estate-debt veteran John Klopp, to lead its property business in the Americas. The soured investments made by the $8.8 billion fund, Msref VI International, continue to be a distraction for Morgan Stanley as it tries to extricate the fund from complex deals around the world.

In many cases, the company can't walk away from foundering investments because the fund made billions of dollars in guarantees. Morgan Stanley now is negotiating with lenders to reduce the fund's obligations on the money it borrowed, its interest payments, renovation costs and other expenses. Adding to the difficulties, the economic downturn and big real-estate losses have rattled some of Msref's core investors, leading to a challenging fund-raising environment. Morgan Stanley has sought to raise a new, $10 billion fund, Msref VII Global.

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HILTON IN STRASBOURG: The fund is handing back an $800 million portfolio of European hotels— including Hiltons in Strasbourg, France; Barcelona; and Dresden, Germany— to lender Barclays Capital.

But it hasn't been easy. For example, the public-employee pension fund in Contra Costa County, Calif., made a tentative $75 million commitment to Msref VII in 2008, but, in February 2009, rescinded it after its chief investment officer wrote a memorandum citing uncertainty over the future of Morgan Stanley, and of its real-estate business in particular. Morgan Stanley ended up settling for about half of its initial fund-raising target for Msref VII, people familiar with the matter say.

News Hub: Morgan Stanley Takes Real Estate Hit
Anton Troianovski discusses how an $8 billion private equity fund at Morgan Stanley lost nearly two thirds of its value.

A Morgan Stanley spokeswoman declined to comment about the losses. She emphasized the company's long-term commitment to real-estate investing. The company's real-estate group has "a longstanding history of investing through many different business cycles over the past two decades," the spokeswoman said in a statement. "We are committed to managing through this cycle and moving our real-estate business forward."

Msref VII is forging ahead with deals for shopping centers in the U.K. and the U.S. In addition to Mr. Klopp, the firm recently hired its former co-head of European real-estate investing, Olivier de Poulpiquet, to head its European real-estate business. The returns of Msref VI could still improve if the global economy recovers faster than expected.

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Morgan Stanley's success or failure at reviving its business will help determine whether private-equity shops run by investment banks play as big a role in real estate in the upcoming decade as they did in the past two. Some of Morgan Stanley's Wall Street competitors, such as Citigroup Inc., have scaled back or sold off their property-fund businesses. Proposed new regulations in Washington could limit banks' ability to manage real-estate funds.

The struggling Msref VI fund once projected a 22.1% average annual return on its commercial-real-estate deals around the world. [[That's an 88.8% reversal of fortune!: normxxx]] When times were good, the fund generated fat fees for various segments of the bank. In 2007 alone, Morgan Stanley earned $104 million in acquisition fees, $22 million in fund-management fees, $13 million in financing fees, $36 million in real-estate-management fees, and $21 million in financial-advisory fees, according to fund documents reviewed by the Journal.

But when the commercial-property bubble popped, the fund turned into a major headache. As credit conditions worsened, Morgan Stanley executives had to spend increasing amounts of their time disentangling the fund's complex deals. About 20% of the $8.8 billion raised for the fund came out of the pockets of Morgan Stanley and its employees. By mid-2009, Morgan Stanley had fully written down its exposure to reflect deep losses in the fund, according to a person familiar with the matter.

SEOUL SQUARE: The $8.8 billion Msref VI International fund expects to lose its $350 million investment in Seoul Square. The $1 billion purchase price in 2007 was the most ever paid for a Seoul office building.

In South Korea, Msref VI expects to lose its $350 million investment in an office building called Seoul Square, according to fund documents. A group of investors acquired it in 2007 for $1 billion— the highest price ever paid for a Seoul office building— with Msref VI taking a majority stake. The third-quarter report floated the possibility of walking away from the deal— but the fund wouldn't be able to do that before making good on $91 million in renovations, guaranteed interest payments, and other obligations, the report said.

Morgan Stanley is still negotiating with lenders and hasn't made the decision to walk away, a person familiar with the matter said. The building is known to Seoul residents for the giant digital display mounted on its façade. In some cases, Morgan Stanley has extricated itself after lenders agreed to reduce some of the fund's guarantees.

In Germany, the fund on Jan. 1 handed a $2.9 billion portfolio of German office buildings back to the lender, Royal Bank of Scotland Group PLC, according to a February presentation to investors. The fund's third-quarter report also said it would return an $800 million portfolio of 10 European hotels, including Hiltons, to lender Barclays Capital, a unit of Barclays PLC. While numerous other real-estate funds may lose more than half their values, the dollar value of the $5.4 billion loss at Msref VI International is likely to dwarf the losses at many competitors because of the fund's large size.

According to data firm Preqin, only two other real-estate funds— managed by Blackstone Group LP and Lone Star Funds— had even raised more than $5.4 billion from investors. As of Sept. 30, Blackstone's $10.9 billion fund had an unrealized, marked-to-market loss of about 60% and less than half of investors' money had been spent, according to a report by the Oregon public-employee pension fund. [[That's pretty neat; they managed to lose more than the half of the funds that were invested!: normxxx]] Lone Star's $7.5 billion fund was up about 15%, according to the report.