10/09/2009

Starwood's Price for Corus Raises Eyebrows

A Starwood Capital partnership's aggressive winning bid for the real estate assets of Corus Bank has left some market pros asking: Did Barry Sternlicht overpay?

The Starwood team's $554.5 million offer was 23% higher than the cover bid, according to market players. Word was that a partnership between Related Cos. and Lubert-Adler Partners offered $450 million. Colony Capital, leading a team that included iStar Financial, J.P. Morgan and Dune Capital Management - also bid close to $450 million. Next was believed to be a roughly $420 million offer from a group consisting of Angelo Gordon & Co., Westbrook Partners, BlackRock and Canyon Capital Realty Advisors.

Starwood and its partners - TPG, Perry Capital, W.L. Ross & Co. and LeFrak Organization - will buy a 40% equity stake in the Corus portfolio, which has a $4.5 billion unpaid principal balance. The FDIC will hold the remaining 60% interest, valued at $831 million, and supply close to $1.4 billion of low-cost loans. That values the portfolio at $2.77 billion, or about 61 cents on the dollar.

By contrast, the Related and Colony bids each valued the portfolio in the vicinity of $2.25 billion, or 50 cents on the dollar. The Angelo Gordon consortium was slightly behind, with a $2.1 billion valuation. The remaining four bids were all below $2 billion.

The wide gap between Starwood's bid and the other offers raised eyebrows among participants in the auction and other market players, who asked why Sternlicht, Starwood's savvy chief executive, saw so much more value in the portfolio than everyone else.

The Corus portfolio encompasses more than 100 loans, mostly subperforming and nonperforming construction loans and commercial mortgages. Many of the construction loans back struggling condominium projects in hard-hit areas, including Florida, Southern California, Las Vegas and Phoenix.

Most observers had expected the portfolio to sell for far less than 61% of face amount. The bids clearly were bolstered by the low-cost financing provided by the FDIC, equal to half of the portfolio's valuation.

Whether the Starwood team made a smart deal may not be known for years. Under the FDIC's structure of the transaction, Starwood, as operating partner, will be motivated to hold most of the assets for several years, rather than liquidate them right away. How much those assets will be worth in four or five years will be based on economic and financial trends that are impossible to predict. But the bidders were forced to come up with a valuation, and the Starwood team was the clear outlier.

In determining bids, investors had to consider that the portfolio has about $500 million of unfunded commitments, effectively increasing the balance to $5 billion. Some bidders also projected $250 million for overruns in construction costs.

High-yield players said the size of Starwood's bid would result in far lower returns than the other bidders were projecting. Using back-of-the-envelope calculations, one investor who looked at the offering estimated that if all of the assets were paid off at face value in three years - what is probably a best-case scenario - Starwood's annualized unleveraged return would be 10-11%. "I'd want a little more reward for my risk," the investor said. By contrast, the investor added, the two top runner-up bids would project a return of roughly 15% under that scenario. His conclusion: The Starwood team used a flawed valuation model.

Starwood wouldn't respond, but some observers said they weren't prepared to question Sternlicht, given his strong track record. "You think Barry Sternlicht has a modeling error? Come on," said one person who in the past has advised the FDIC on asset management. "Perhaps he just sees more value. You just can't bet against him."

To be sure, if Starwood achieves its yield hurdles, the amount it paid would be moot. The firm typically shoots for gross leveraged returns of 16-20%. Said one person familiar with the Starwood team's viewpoint: "The investor team received a 40% discount to book value. They don't feel they overpaid."

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