Deconstructing the brewing US real estate crisis

One scoop to start: Months of talks to sell SoftBank Group-owned asset manager Fortress Investment Group to Abu Dhabi sovereign wealth fund Mubadala have reached a late stage, with the parties close to a deal for as much as $3bn.

In today’s newsletter

• Commercial real estate on the brink

• The mattress deal with a dark history

• Private equity struggles to agree on price

Office space: in commercial real estate

A $300mn San Francisco office tower likely to sell for cents on the dollar, investors turning over property keys to their lenders and a crisis that has US regional banks pulling back on loans.

If there’s one unavoidable topic for fund managers and Wall Street executives, it’s the brewing troubles in the $5.6tn US commercial real estate (CRE) industry, DD’s Ortenca Aliaj, Antoine Gara and Eric Platt report.

CRE is at the centre of the storm with rising interest rates, falling property valuations and waning demand for office space expected to wreak havoc on the sector. In a Federal Reserve survey released on Monday, a majority of US banks said they tightened credit standards for loans secured by non-residential properties in the first quarter, while none loosened standards.

That could end up being a big problem for CRE because regional banks contribute a significant chunk of the lending to property owners, as much as two-thirds by some measures.

With more than a trillion dollars of CRE debt due before the end of 2025, property owners may start to find it difficult to borrow more cash, and even if they can, they face significantly higher borrowing costs.

“The private market hasn’t started to heavily mark down real estate,” said Apollo Global Management co-president Scott Kleinman. “The equity will be first. That’s the next shoe to drop in the US.”

Kleinman isn’t alone. Berkshire Hathaway vice-chair Charlie Munger warned of a brewing storm in the US commercial property market, saying banks were “full” of “bad loans”.

But some corners of Wall Street think the risks are being overstated.

Brian Kingston, chief executive of Brookfield’s real estate business, one of the largest players in the sector, pointed out that there are issues with traditional office properties. Newer buildings and other assets, such as multi-family and high-end retail have held up well. “Making broad generalisations about commercial real estate can be dangerous,” he said.

The reality is that it’s difficult to know exactly what shape the commercial property market is in. As Barclays recently pointed out in a report, only a small portion of CRE is securitised so it’s difficult to get accurate data on how it is performing.

Still, what no one wants to do is underestimate just how bad things could get. As the chief executive of a major US bank pointed out: “Commercial real estate is leverage on leverage on leverage . . . if people are forced to quickly unwind that leverage it can pop up in other places.”

The rusty springs beneath a $4bn mattress deal

Mattress M&A is usually fodder for lame bedding-based puns, and Tempur Sealy’s $4bn deal to buy Mattress Firm announced on Tuesday is no different.

America’s biggest bed manufacturer and a major retailer are getting under the covers — groan. But beneath the bouncy idioms, this particular deal has a rather dark history, the FT’s Joseph Cotterill writes in a DD dispatch from South Africa.

That’s because the transaction’s major seller, with a 45 per cent economic interest in Mattress Firm, is Steinhoff, the Frankfurt and Johannesburg-listed retailer.

Steinhoff’s own $3.8bn acquisition in 2016 was a major milestone on the way to its collapse in South Africa’s largest ever corporate fraud just over a year later.

The entry into America was part of a dealmaking spree for furnishing world domination by Steinhoff’s former chief executive Markus Jooste, who also bought the UK’s Poundland among other international assets. But it soon blew up.

Mattress Firm sales foundered (it also had a dispute with a key supplier — one Tempur Sealy). Years later, Jooste told a South African regulator the deal was a “disaster”.

By then of course, Steinhoff itself was a disaster, after the discovery of accounting irregularities all but wiped out its shares. Jooste, who denies wrongdoing, faces probes in Germany and South Africa.

Steinhoff embarked on a years-long attempt to salvage the company, which has €10bn in debt. Mattress Firm itself spent a period in bankruptcy protection in 2018 and closed hundreds of stores. It pulled plans to list earlier this year.

These days, after a series of asset sales, shareholder lawsuits and arcane creditor negotiations, Steinhoff is in hot water.

The company recently overhauled a plan to avoid liquidation after a shareholder revolt over terms that would have left them without equity after a delisting. They would now have rights to a fifth of the rebuilt company if the plan is approved this month.

Steinhoff will at least be able to use the $1.2bn cash it will receive from Tempur Sealy to pay some of the debt (it will also own 7.5 per cent of the merged group).

Still . . . talk about M&A monsters under the bed.

Private equity’s price predicament

DD has written before about the clubby ranks of private equity and its lucrative tendency to sell to itself.

The practice provides a ready source of deal flow for cash-rich buyout houses, as well as an easy exit route for firms looking to monetise their investments.

Over the past few weeks, though, a handful of closely watched deals between private equity firms in Europe have stalled as buyers and sellers have struggled to agree on price, DD’s Will Louch and Ivan Levingston report.

Advent’s planned multibillion-euro sale of biometrics technology company IDEMIA failed to win an attractive bid from potential suitors. BC Partners’ VetPartners attracted bids and secured financing but is still deliberating whether it could sell the veterinary clinic chain for a higher price when the economic outlook brightens, according to people familiar with the matter.

The reason why these deals aren’t getting done is simple, said Bank of America’s global financial sponsors co-head Saba Nazar. “The LBO math doesn’t work — valuations remain inflated and the cost of borrowing has gone up.”

Taking companies public — another favoured exit route for private equity — is also tricky. Initial public offerings in Europe had their second-worst quarter since the Covid-19 pandemic, PitchBook data shows.

The inability to realise gains is prompting firms to get creative to return money to their backers. One tactic being used involves so-called continuation funds, which can help investors cash out without having to sell or list an asset.

Private equity’s game of pass-the-parcel has become so prevalent that Amundi’s Vincent Mortier likened it to a Ponzi scheme last year, forecasting a future reckoning.

If the dealmaking environment doesn’t improve, that day could come sooner than expected.

Job moves

• UBS has said Credit Suisse chief executive Ulrich Körner will join its executive board to help steer the integration of the bank, as rivals attempt to capitalise on what is expected to be a fraught process.

• Activision Blizzard has hired legal heavyweight Lord David Pannick KC to lead its fight against the UK competition regulator’s decision to block its $75bn deal with Microsoft.

• Rothschild & Co has hired Daiwa Securities’ former co-head of investment banking Yuichi Akai as vice-chair of Japan, based in Tokyo.

Smart reads

Solar-powered Ponzi scheme The Atlantic chronicles the tale of DC Solar, the “renewable energy powerhouse” that swindled the likes of Warren Buffett and the US Treasury.

Sequoia in flux Roelof Botha’s reign over the venture capital firm has been marked by bad bets and a regulatory stand-off over its stake in ByteDance, The Information reports.

Guessing game Last week US regulators awarded someone a historic $279mn for blowing the whistle on . . . well, no one knows. Alphaville ponders who the loot went to and why.

News round-up

Goldman Sachs to pay $215mn to settle gender discrimination lawsuit (FT)

Sam Bankman-Fried asks US court to dismiss criminal charges over FTX (FT)

Tesco chair John Allan and CBI’s law firm in war of words over misconduct allegations (FT)

Deloitte under investigation by UK regulator over Joules audit (FT)

Adidas to face pressure from big investor over Kanye West findings (FT)

Fox defends settlement with Dominion as a ‘business decision’ (FT)

Buffett/capital allocation: Berkshire’s cash earns big interest while deal hunt continues (Lex)

Apollo: alternative credit group must dispel fears of an ‘annuities run’ (Lex)