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Lennar's Rialto Grows Appetite With Second Distressed-Property Fund

By Amy Or and Al Yoon NEW YORK--Lennar Corp. (LEN), one of the nation's largest home builders, is seeking to raise $950 million to invest in U.S. distressed real-estate debt, assets and securities for its investment-management unit, according to a document sent to potential investors. The new fund, managed by Lennar's wholly owned unit Rialto Capital Management LLC, is more than 35% larger than its initial fund, which raised $700 million in November, underscoring the huge market opportunities Rialto sees as the industry deals with the excesses of the real-estate boom. The fund, named Rialto Real Estate Fund II LP, targets a gross internal rate of return of 17% to 20% and expects to have an initial close in the third quarter this year, the document said. The expected return, while lower than the estimated net gain of more than 20% for its predecessor fund returned so far, is still deemed extremely attractive considering the current low interest-rate environment and choppiness in equities markets on global economic concerns like the unfolding European sovereign-debt crisis. Fundraising efforts for the second fund is the latest sign of growth for Miami-based Rialto, led by former LNR Property Corp. Chief Executive Jeff Krasnoff and former Morgan Stanley (MS) head of real-estate investments Jay Mantz. The new fund's strategy includes buying, recapitalizing and refinancing distressed assets amid an "unprecedented level of pending debt maturities of over-leveraged assets," it said in the investor document. Rialto and J.P. Morgan Chase & Co. (JPM) in April were the first to resurrect a type of commercial mortgage-backed security, or CMBS, used in the aftermath of the savings-and-loan crisis of the 1980s and 1990s to fund their purchase of subperforming loans. The Blackstone Group and Square Mile Capital followed with distressed-loan CMBS, and a pipeline of new issues is building, analysts said. Rialto's new, larger fund suggests distressed opportunities are rising. Distressed funds immediately following the financial crisis and recession raised billions of dollars but were slow to deploy the capital. Now, the increased ability of investors to fund the assets with debt and more attractive pricing to sellers may prompt heavier deal flow, industry observers said. The new fund may also buoy Rialto's earnings, which have been lackluster in the second quarter. The asset manager, a main revenue generator for Lennar especially in the aftermath of the housing bust, posted a 56% drop in operating earnings to $4.3 million for the three months ended May 31, compared with the $9.8 million a year ago. It accounted for about 4% of Lennar's $930 million revenue for the second quarter. Calling the earnings "not where we'd like to see them," a Rialto executive placed part of the blame on borrowers' and guarantors' reluctance to repay loans in Rialto's distressed-debt portfolios. "More recently, we have seen this turn into an increased effort by a number of investor and developer obligors to alter existing laws to frustrate the original contractual terms of the underlying loan agreements, specifically to limit our ability to collect what is due," said Rialto's Chief Executive Jeffrey Krasnoff during Lennar's earnings conference call Wednesday. But he said the company's distressed-debt investments have continued to "materially exceed" its expectations of timing and amount of gains. The new $950 million fund is eyeing opportunities on the $230 billion in outstanding distressed debt as of the last quarter. Nearly half are held by international firms and banks insured by the Federal Deposit Insurance Corp., which are under regulatory pressure to divest assets weighing on balance sheets, Rialto said. Rialto also said limited competition and better loans will also provide opportunities to buy junior tranches of new CMBS at favorable risk-adjusted returns. It has been one of the most active buyers of these so-called B-pieces as the CMBS market slowly recovers. Rialto's first U.S. distressed real-estate fund acquired assets at about 40 cents on the dollar and has invested $566 million of equity so far in 33 transactions, the document said. The company said the fund has realized $130 million in cash gains, or what are known as "cash flow and realizations," as of May 31, which is "significantly ahead of original estimates." A Rialto executive declined to comment. Write to Amy Or at [email protected] and Al Yoon at [email protected]

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