Kappenman says there was immediate support from investors, and the fund closed in 90 days. The selection criterion is three-fold, Kappenman says. The assets need to be office, retail, industrial or multifamily loans or properties between $5 million and $20 million in price and with a high-teens IRR target.

These properties exist, though the wheat must be separated from the chaff, he says. In to day's bifurcated markets, there are only two kinds of activity going on: High-quality assets trading at aggressive pricing, chased by reputable capital and helped by high interest rates, and the lower end, where an asset has a broken ownership, a broken management component or is owned by a bank or lender that does not plan to be a long-term holder. "Anything in between seems to be pretty anemic right now," Kappenman says. "We want to focus on the latter opportunities. We'll start in the Midwest and some of the major markets where we have boots on the ground."

He believes owners in trouble, and their lenders, are going to have to come to terms with the realities of the market in the next two years. Where the past 24 months saw virtually no activity, movement on these lower-end properties should start in earnest by 2012, Kappenman states. "We're probably going to see distress for a number of years after that," he says. "This downturn is different than others. You see across a lot of real estate that is upside-down relative to its debt and current valuation, and it's not going to fix itself. Properties that missed one or two payoffs and squeaked by are now working into their third down year. Banks are starting to run into their third and fourth extensions, and regulators are going to start clamping down."

While it is just Kappenman and Paulson at the oars of NorthStar, the fund employs experienced real estate professionals from all aspects of the distressed real estate market, such as the staff at each of the 32 Northmarq Capital mortgage banking offices. Northmarq will provide investment sourcing, mortgage servicing and administrative and operation support, Kappenman says, and United Properties will handle acquisition selection, due diligence and asset management activities.

Kappenman also serves as a managing director at Northmarq. He has 22 years of real estate and finance experience, including lead management responsibilities for four publicly traded, closed-end bond funds that he ran for 14 years. Paulson has 15 years of real estate finance experience, including 11 years of portfolio and asset management.

He says the employees within Northmarq and United Properties have the know-how to tackle distressed assets. They've completed due diligence and acquisition of several million square feet of retail, office and industrial properties in the past five years, along with acquisitions of a number of loan portfolios as direct equity investors and joint-venture partners.

Northmarq and United Properties have a long history of teamwork, going back nearly a century. In early 2008, as development waned and the financial side of the market picked up, United Properties merged much of its staff into NorthMarq. The real estate divisions have since been redistributed, with most employees of the two companies now operating under the NorthMarq name.

NorthMarq Real Estate Services was formed to handle the United Properties divisions, including brokerage, property management, construction and corporate solutions. NorthMarq Corporate Solutions and NorthMarq Capital help lead the expansion of both the company's outsource work and its investment sales.

Boyd Stofer is chairman and CEO of a holding company that oversees the real estate services and United Properties divisions. At the time of the merger, he said the joining would help the firm break out of the former concentration on the Midwest. However, he also said that times would be tough for the development side of the business.

He was right. Frank Dutke, president of the investment and development businesses at United Properties, agreed the market was almost a dead-end for the past two years. Today, Dutke tells DAI that that his company is finding opportunities. United Properties is working on the renovation of a historic office building in the Minneapolis Central Business District and another mixed-use assetin the suburbs. Dutke says he thinks the cycle will start picking up again in 2011, and this new NorthStar fund will also keep business percolating.

"It's a significant opportunity for us as a company," Dutke says. "With United Properties, we can add the most value to NorthStar through acquisition and underwriting, distinguishing those properties that are good and those that are not so good. We can help get the transaction closed and execute the business plan, coming up with a property fix plan that fits the asset."

Like everyone else monitoring the capital markets, Dutke says he thought there would be more distressed-asset opportunities, deals that have for the most part not materialized. At some point, however, the commercial real estate industry has to go through some significant deleveraging, he believes. "All that debt that was incurred at high volumes in 2005 through 2007, that debt has to be recapitalized. I'm pretty confident that this opportunity will come, and I'm happy we have the capability to execute when the opportunity begins."

Philip Reuter, a senior investment analyst with State Farm Insurance Cos., says he thinks the NorthStar fund is a perfect idea in to day's economy. He's partnered with United Properties for 10 years on commercial mortgage loans and joint ventures, including

the 200,000-square-foot Centennial Lakes office complex in Edina, MN. He says the Northmarq/United Properties group has always provided multifaceted, valuable assistance to its client base, and if they catch the right lull in the distressed cycle, the NorthStar fund will do well. "There's going to be plenty of opportunity for distressed funds, and a lot of lenders and banks have in fact kicked the can down the road," he says. "You'll see more distressed sites coming up in the next couple of years."

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