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Hedge Funds Brawl Over Battered Commercial Real Estate

They can battle all they want, most of these underlying properties are going to crater and go back to their lenders as the quadruple hit of higher real estate taxes, doubling of interest rates, dropping occupancy, and ramped-up urban crime is overwhelming.


Each property is a ticking time bomb so long as it has a loan maturing in the next 1-4 years.


Hedge Funds Brawl Over Battered Commercial Real Estate

Distressed investors are fighting over REITs trading at discount prices

By Matt Wirz, WSJ

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July 23, 2023 5:30 am ET


Big fund managers that specialize in distressed investing have eagerly watched the yearlong selloff in commercial real estate. Now, they are snapping up battered shares of real-estate investment trusts, historically the province of mom-and-pop investors.


The influx of these funds is lifting prices, benefiting individual investors who held on. It is also sparking conflict as hedge funds bid against one another for shares and butt heads with management teams.


D.E. Shaw, Flat Footed, H/2 Capital Partners and Lonestar Capital purchased at least 20% of the shares in a REIT called Diversified Healthcare Trust this year, according to data from S&P Global Market Intelligence. In April, the management company that runs Diversified Healthcare announced plans to merge it with an ailing office REIT it also controls in a deal the funds said would tank their investments.


The two sides have since gone to the mattresses, fighting over the future of the REIT.


“It’s been crazy town ever since the announcement of the deal,” said Bryan Maher, a REIT analyst at B. Riley who has a buy recommendation on Diversified Healthcare. “I’ve never seen anything like this.”


Commercial real estate is suffering an epic downturn. Rising interest rates are pushing prices down at the same time that demand for office space is suffering because many employees continue to work from home.


Storefronts that went vacant during the pandemic remain empty, victims of online commerce—and even the hot medical properties sector hit an air pocket this year.


At the same time, bargains have been hard to find in the stock market. Stock indexes unexpectedly surged this year and fears of a looming recession have eased. With relatively few other options, distressed investors are flocking to REITs, especially those with low office exposure that got caught in the wider selloff.


REITs buy up properties or lend money to real-estate investors and distribute most of their rental or mortgage income as stock dividends. They have been popular with individuals who lack the means to purchase and manage real estate themselves. REITs were commonly thought of as a defense against inflation.


Those REITs specializing in offices lost 10% counting price changes and dividends this year through July 13, while those specializing in retail returned 3%, according to industry group Nareit. Residential REITs held up better, returning 13%, but still lagged behind the 19% delivered by the broad S&P 500 stock index.


The market capitalization of Nareit’s widely followed index tracking all REITs has dropped by about $200 billion, to $1.3 trillion, over the past two years. REIT investors started pulling money from the funds, punishing managers such as Blackstone that had capitalized on the trend.


“We’ve been tracking the mortgage REIT space for a while and we’ve started to see some underperforming ones face challenges because they don’t have access to capital markets,” said Vik Uppal, chief executive of Mavik Capital, an investment fund and REIT manager.


He isn’t alone.


Mavik announced in June a planned merger of its REIT with Western Asset Mortgage Capital. The REIT owns mortgages to a mix of residential and commercial properties and its stock price had fallen about 50% in the past year. Two weeks later, Angelo Gordon, a much larger hedge fund and REIT manager, made an unsolicited takeover bid for Western Asset.


Angelo Gordon claims its offer is superior and that Mavik’s deal poses many risks. Mavik says similar things about its own transaction. Western Asset said in a press release that it will engage in discussions with Angelo Gordon’s REIT and that the deal with Mavik’s REIT remains in effect.


The jostling over Western Asset has been civil compared with the brawl over Diversified Healthcare, which owns senior living communities, gyms and medical offices.


D.E. Shaw, Flat Footed, H/2 and Lonestar Capital bought up shares of Diversified Healthcare this year after the stock lost about 80% of its value in 2022. They were betting the REIT’s retirement communities, which struggled to attract residents in the pandemic, were about to get an influx from aging baby boomers.


The stock rebounded in March, after Diversified Healthcare reported a 5% bump in 2022 senior-living revenues and gave a favorable forecast for this year.


Then, the REIT’s manager, RMR Group, announced plans to merge it with another REIT it controls, Office Properties Income Trust, which is struggling to retain tenants. The deal offered Office Properties shares valued at about $276 million in exchange for Diversified Healthcare’s $3.8 billion of net assets, according to a regulatory filing by Office Properties.


Diversified Healthcare shares fell back below $1, near their record lows, and Flat Footed and others hired lawyers and a proxy adviser to fight the deal.


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“We are concerned that RMR is using the combination with Diversified Healthcare to fortify Office Properties and therefore preserve its own lucrative management fees,” D.E. Shaw said in a presentation advising Diversified Healthcare shareholders to vote against the merger.


The two sides have been snapping up shares ahead of an Aug. 30 vote on the transaction. Investors opposing the merger control at least 28% while RMR Chief Executive Adam Portnoy took the unusual step of purchasing about 10% after announcing the merger.


RMR didn’t recommend the merger to shore up Office Properties or protect its fees, a person familiar with the firm’s thinking said. The deal is meant to fix Diversified Healthcare’s finances before a $450 million bank loan falls due next year, he said.


The tie-up will put Diversified Healthcare back in compliance with terms of the bank loan and renew its access to capital markets, according to a statement by the REIT’s chief executive, Jennifer Francis. Francis is also an executive of the RMR Group.


Diversified Healthcare’s stock has surged to around $2.50 in recent weeks, more than twice what it would be worth under the merger, reflecting expectations that the ‘no’ votes will win.


“I am with Flat Footed and I am very glad they stepped up,” said Shashi Karan, a 69-year-old retiree from Seattle who owns Diversified Healthcare stock. “These REITs are run by RMR for their benefit, not for the shareholders.”


Write to Matt Wirz at matthieu.wirz@wsj.com

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