Here’s a story for the decade. Morgan Stanley’s Msref VI, an $8.8 billion real estate fund, lost $5.4 billion, the biggest loss in the history of private real estate equity investing. This story is just out from the Wall Street Journal and it is worth a read.
It isn’t clear from the article, but they bought many of their properties in 2007. I don’t have to tell you how insane of a move that was when the U.S. housing market was collapsing. One of their big misses was the Eurotower in Franfurt which, ironically, is the home of the European Central Bank.
I’ll give you a hint what may have motivated Morgan; according to the article:
When times were good, the fund generated fat fees for various segments of the bank. In 2007 alone, Morgan Stanley earned $104 million in acquisition fees, $22 million in fund-management fees, $13 million in financing fees, $36 million in real-estate-management fees, and $21 million in financial-advisory fees, according to fund documents reviewed by the Journal.
Here are some highlights of the article:
The soured investments made by the $8.8 billion fund, Msref VI International, continue to be a distraction for Morgan Stanley as it tries to extricate the fund from complex deals around the world. In many cases, the company can’t walk away from foundering investments because the fund made billions of dollars in guarantees.
Morgan Stanley now is negotiating with lenders to reduce the fund’s obligations on the money it borrowed, its interest payments, renovation costs and other expenses. …
As credit conditions worsened, Morgan Stanley executives had to spend increasing amounts of their time disentangling the fund’s complex deals. About 20% of the $8.8 billion raised for the fund came out of the pockets of Morgan Stanley and its employees.
I have been very critical of the state of current economic thinking by financial institutions, especially their analysis of the causes of business cycles (see “The Smartest Guys in the Room). It appears, like many of their counterparts, Morgan Stanley never saw it coming. Many institutions didn’t want to see it coming because the fees were too good.
Another criticism is the poor analysis of risk in investments. Being a big fan of Nassim Taleb and Benoit Mandelbrot, I believe the investment risk models that are still being used on Wall Street despite the disastrous investment results, are inadequate to protect investors from “fat tails” and “black swans.” While I understand that financial markets analysis differs from real estate investment analysis, they both construct models that ignore the possibility of major systemic risks.
Real estate analysis takes into account regional differences and economies, but I have seen little competent analysis of macroeconomic impacts either regionally or globally. In this crash, did no one see that residential real estate was riding a credit bubble, which, if collapsed, would devastate credit markets, reveal vast commercial overbuilding and inflated cap rates that relied on asset appreciation to make sense?
As we all know, the answer is, no.
Here is part of their press release (Jun 20 2007) upon the completion of the funding of Msref VI:
“The record size of this fund, both for Morgan Stanley Real Estate and among real estate investment managers, is indicative of strong capital flows into real estate as new investors seek exposure to the asset class and existing investors increase their allocations,” said John Carrafiell, Managing Director and Global Co-Head of Morgan Stanley Real Estate Investing. “Real estate is increasingly becoming an important component of an asset allocation strategy because it offers portfolio diversification and the ability to invest in ‘real’ assets, which provide uncorrelated investment returns compared to other asset classes.”
“We believe that attractive opportunities to invest in real estate around the globe will continue as demand for all asset types outpaces supply,” said Sonny Kalsi, Managing Director and Global Co-Head of Morgan Stanley Real Estate Investing. “Global employment growth, an aging population in the west, a growing population in the east, and accelerating urbanization in many emerging markets will drive the need for all types of quality real estate.”
I’ll bet they wish they had never said that.