Brookwood Takes Residential Respite from Chaotic Commercial Market

It might appear counterintuitive for a significant private equity player, having chucked most of its commercial real estate at the height of the market, to then take refuge in the seemingly even more troubled residential market, but that’s exactly what Brookwood Financial Partners L.P. has done. About 10 days ago, Brookwood announced that affiliate Brookwood Value Partners L.L.C had made the first purchase under its new strategy of acquiring finished residential lots. The acquisition covered 214 finished lots in The Grove, Lehigh Acres, Fla., from national homebuilder D.R. Horton Inc.; Brookwood has also contracted to buy another 140 lots once they’re finished by Horton. The sale came after a period in which Brookwood had been a net seller of commercial properties, divesting itself of 28 multi-tenant office, flex and retail properties totaling more than 4.75 million square feet in nine states. The total proceeds, according to the company, came up to $650 million. So what’s driving this? Strategy? Desperation? Opportunism? Last week, CPN spent some time talking with Brookwood chairman & CEO Thomas Trkla (pictured) and getting a sense of how Brookwood’s past helps explain its plans for the next couple of years. This latest purchase both breaks a long, intentional drought in Brookwood’s acquisitions and represents a strategy that the company had in mind during the peak of the recent commercial real estate boom. But first a little history on a company that has pretty much followed one of Trkla’s mantras: “We don’t force markets.” Whatever WorksEstablished in 1993, Brookwood spent its first two or three years pursuing “a turnaround strategy … buying stuff we thought would turn quickly.” Trkla said. The company’s focus was primarily office and retail with some multi-family and flex properties, all property types mostly Class B. In 1997–98, Brookwood moved a little more upscale, targeting Class A properties in markets like San Diego, East Bay/Oakland, Phoenix and Miami. But by 2001–02, they had stopped buying, though not for lack of wanting to. “We were trying like hell” to buy something, Trkla said, but simply couldn’t make the numbers work to their liking. The following couple of years, roughly 2003–04, Brookwood bought and flipped a lot of properties. The difference between Brookwood and a lot of investors who got burned, Trkla said, “is we got out.” Starting about three years ago, Trkla said, with the market heating up, “We thought cap rates were crazy.” Worse, he added, they saw more and more deals with “ridiculous rent growth assumptions” in the underwriting. Over a two-year period, Trkla said, “Basically, I sold everything I bought from ’93 to ’05…. We got ridiculous prices.” “When it becomes that easy,” he told CPN, “the light bulb sort of goes off” that the good times will be coming to an end. In about the same time frame, Brookwood’s acquisitions tapered off and then stopped. Their next-to-last purchase was in March 2007, involving a 602,000-square-foot multi-tenant office building in Beverly and Danvers, Mass., plus a smaller property, bought for $71.5 million. The last one was in July 2007, an all-cash purchase of a 250,000-square-foot office/flex complex in Rhode Island. And that’s it. Brookwood hasn’t bought any commercial real estate at all in the intervening 24 months. “It’s very hard to justify buying commercial real estate right now,” Trkla said. “If you think values are going down, how do you price a deal?” “What we didn’t buy” was a crucial part of their nearly 33 percent return on the properties they’ve sold, he said. Still, for anyone in the business, he conceded, “The hardest thing to do is not buy a deal.” Foray into Residential On the residential side, Brookwood is talking with Horton and several other national homebuilders about a total of seven possible deals, Trkla said, and is also looking at raw land. Southwest Florida is their primary target, he said, mentioning Naples, Sarasota and Ft. Myers as cities he likes. “That’s our favorite area in the U.S. right now.” Other markets in Florida are possibilities, as is New Mexico, though Trkla is emphatic that California and Nevada are not yet on the list. Brookwood is looking for areas with population growth and good quality of life and will be back in southeast Florida in a year. Overall, Trkla expects Brookwood to run with its residential lot strategy for 12–18 months and said that the company probably won’t be as deeply into residential real estate as they ever were into commercial. Brookwood is looking to acquire $50 million to $100 million through next year and is “underwriting holds of two and a half to three and a half years from today” in residential land buys, he said. Return to CommercialThat 12- to 18-month period is also when Trkla expects to see deal flow improve on the commercial side. “We’re not out of the commercial market at all,” he emphasized, noting that Brookwood is still holding about a quarter billion dollars’ worth of commercial real estate and also still has some of the properties they bought in 2006 and 2007. Trkla isn’t seeing a lot of distressed transactions on the commercial side at the moment, but does expect to see some over the next two to three years as bullet loans come due. Those completely unrealistic rent growth projections are “going to blow up a ton of deals,” he predicts. The signal difference between the market situation now and that back in 1989, Trkla said, is the “huge institutionalization of debt and equity,” with vastly fewer and larger players, a factor that will strongly affect how long distressed properties will be held. He sees “a huge equity gap” developing and the concentration of ownership is only “delaying the inevitable.” For Brookwood’s part, Trkla said, having sold off such a large part of their portfolio means that “we get to play offense and not defense.” And being privately held is a big advantage, too. “I’m owned by nobody,” he said. “When I don’t want to buy, I don’t buy.”