"Let's say you formed a fund in August of 2007 when the credit markets first started to freeze up," says Herrick, Feinstein partner Gary Eisenberg, "and it had a three-year horizon on the premise that there was a lot of distressed debt coming to market in

the next few years. You might be in a situation where you're pressing up against a timeline. That's a worry."

Simply put, there isn't a lot coming onto the market. "Everyone forgot that the guys selling the assets were around back in the RTC days, too," notes Fink. The banks and the government are determined not to repeat the losses that were taken in those deals, he points out. Back then, the RTC kept residual interest on the deals, so the leftover assets went back to the government, which it then turned around, sold off and put money into the general fund, he explains.

"So, when you look at what the FDIC is doing," Fink explains, "they're using the incentive of returns on investment to get people to work the asset but are continuing to take a partnership interest. To the extent there is an upside, beyond an economic return that the FDIC thinks is reasonable, they want to participate in it. And that's a new feature for a lot of people." That preservation of value has led to slower transaction velocity.

The constrained pipeline and the pretend-and-extend mentality of banks has made it hard for large funds to get money out the door. However, there are some players who have made deals--on opposite ends of the spectrum. Most notably, Starwood Capital Partners

has had some very active funds, including its purchase of a Corus Bank $4.5-billion loan portfolio through the FDIC.

Meanwhile, David Reiner's Grosvenor Investment Management has found success taking its Grosvenor Residential Investment Partners I fund into smaller plays. Reiner's fund was originally set to be $200 million, but it had trouble gathering enough capital, resulting in a $100-million pool. Grosvenor's original play was to purchase for-sale residential family and town homes, but the fund, which was created in March of 2007, quickly morphed into a distressed asset reserve. Having the luxury of waiting, the company sat on its fund for about 18 months until the market began to shake itself out. Grosvenor now purchases housing lots as well as troubled empty or unfinished projects at large discounts from banks and homebuilders. The company then repositions and shops them. This is in contrast to institutional investors who are currently searching for core assets, very few of which are making their way onto the market. "Our investments are typically between $5 million and $10 million," Reiner explains. "When you raise enormous amounts of money, it takes away some of the flexibility you have in terms of doing smaller transactions," Reiner says. "You simply can't get the money out quickly enough."

However, Grosvenor isn't aiming for a quick turnaround. "Our first investment was in New Jersey in July 2008," Reiner explains. "It was a two year investment that just paid off this past June." He notes that there was a long lag between that first deal and the next few that came along, most of which developed through 2009. And even with an early entrance, the fund has deployed only half of its $100 million, so far.

"If you buy assets today, you do so with the intent to own, operate and turn them around," Fink explains. "This is not a financial distressed real estate play where you buy five assets, split them up, sell them and make a profit by piecing them out," Some of the early funds were prepped for that market, which never materialized. Experience in real estate is what may pay off as these assets become available.

"The assets that are available today are generally those where real estate operating knowledge is important for purposes of making a profit," Fink notes. These companies and funds will also do better if they figure out the underlying issues of each asset before they get involved in a bidding war.

"The companies that have been successful in accessing deals have typically been willing to invest resources in doing due diligence in advance of seeking a specific deal," Eisenberg says. The risk is setting up an operation to pursue the deal and incur costs without knowing that anything will come of it.

The availability of funds becomes an issue, since front-end money raises the stakes on a property's eventual cap rate, which has been driven lower through highly competitive bidding processes. And, Eisenberg points out that lending isn't the best business right now for financial institutions, since T-bills are showing more return.

So many funds are still waiting for bids to come down. And the longer pretend-and-extend persists, the higher the risk of asset deterioration as borrowers who assume an eventual foreclosure, and subsequent loss of the asset, refuse to put any more money into the property.

Meanwhile, the lender has no incentive to invest in a property that is already underwater and showing a loss. This leads to a deceleration in property value, notes Eisenberg. Normally, this isn't an issue for a bank, but in the case of many distressed assets now, "the liquidation value is below the outstanding value of the loan, but the cash flow on the property or the cash flow post-borrower equity continues to make good on the loan," Fink explains. Pre-credit crunch, he says, it would be an easy decision to foreclose on a bad loan with declining value. Now it's not such an easy choice. "Selling assets into a fire-sale market is not the best way to maximize yield." But Eisenberg feels that banks will have to make the hard choice.

"At some point there has to be a recognition in the marketplace that forced liquidation of some of these assets needs to occur so they can be transferred to someone who can operate them at a lower basis," he says.

"Otherwise, you're going to have a lot of trouble cleaning up the real estate market and generating any kind of product flow for real estate investment opportunities."

Fink disagrees, "Pretend-and extend is really catchy, but I don't know anybody in the banking world that's pretending they don't have troubled assets." He says that if banks are forced to "liquidate these assets and as a net result they wipe out the bank's capital, it ends up on the insurance fund. And the insurance fund is already in extreme financial distress at the FDIC." Campbell agrees, pointing out that transactions are already picking up in 2010. It would be good for real estate professionals to create a higher volume of transactions, he says, but it might not be the best thing for the economy or the banks. Fink explains, "There's no way to speed the process unless you're willing to have a lot of bank capital destroyed and the institutions put out of business."

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