Madison Realty Capital - A Private Commercial Lender

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By Chidem Kurdas
December 11, 2007

NEW YORK (HedgeWorld.com) – You might think that conditions are not ideal for real estate-dedicated hedge funds, what with US housing in a slump and enough subprime mortgage defaults to qualify as a national emergency.

It is not possible to know how the funds are doing as a whole because the sector is so new there is no publicly available database or index. But anecdotal evidence suggests that many are doing very well, funnily enough in part because of the credit crisis.

This is a diverse group. A growing number of hedge funds pursue a range of strategies in real estate, including specialized niches. While some search globally for high-profit investments, others concentrate on one market.

Here we look at a US-focused credit strategy. HedgeWorld asked the managers of Madison Realty Capital to discuss their approach. The firm, launched in May 2005, specializes in bridge loans for commercial properties. Its investors are institutions from around the world.

Josh Zegen, managing partner at Madison, previously worked at the asset-backed finance and securitization part of Merrill Lynch’s capital markets business and at Salomon Smith Barney’s leveraged buy-out group. Adam Tantleff, managing partner at Madison, came from Suffolk Capital Management LLC.

HedgeWorld: Why do property owners come to you for loans, instead of going to a bank?

Josh Zegen: We are paid for speed. The borrower may have a great asset, but needs money quickly. We decide and act within two to three weeks. They might want to buy an office building and will lose their down payment if they can’t close in time. For instance, this September a group in NYC needed money to close a deal in two weeks and the bank required additional equity. So they came to us.

HedgeWorld: How is business nowadays?

Adam Tantleff: This environment is perfect for us, because there’s no liquidity in the market. Besides our edge in situations where time is of essence, people also come to us for the greater certainty. While our rates are a little higher than what a conventional lender charges, in the credit crunch people are willing to pay a higher rate to get the certainty that they will be funded and not be left at the alter!

Josh Zegen: It has been a great opportunity for us in last six months. Since the inception of the fund we’ve closed around 150 transactions, with over $600 million in loans. This November alone we did $70 million in deals, many in the New York metro area, which used to be very competitive but now even here there are liquidity issues.

HedgeWorld: When did you notice people becoming more desperate to finance deals?

Josh Zegen: Specifically, in July. You start to sense it from all the other lenders. Lenders no longer knew what rate to quote, because if the quoted rate is too cheap they have a loan under water. Not knowing what the market is, it’s very tough to quote.

HedgeWorld: Isn’t that a problem for you as well?

Josh Zegen: Not to the same extent because we don’t sell the debt – we hold it. We don’t need to find a buyer willing to securitize it. Investment banks have to be very careful what they quote because they plan to move it along, but no one knows what to expect. A lot of the dislocation in the market happened because investment banks can’t move loans off their books to the collateralized debt market, so they’re backed up. Since they’re not originating new paper, they're not lending. That knocked out a huge percentage of the lending market. Who’s left? You have opportunity funds like us and the savings banks, which are also on-balance-sheet lenders. They are now busier than they have been in the past five years.

Adam Tantleff: Another factor is the short duration of our loans. Our turnover is one to two years. That means there is a self-correcting mechanism in the portfolio. As old loans are replaced by new loans in the normal course of business, we reprice risk to reflect new conditions.

HedgeWorld: Going by news headlines, American real estate doesn’t look like a good bet right now. Isn’t there a high risk that property prices will go down further?

Josh Zegen: We’ve had a significant number of payoffs already, suggesting we’re doing the underwriting right. Our loan-to-value ratio is low – on average around 62% in our portfolio. Plus, we mostly have senior secured positions. Even if the market drops by 20%, we would get all our money back in the event of liquidation. In any case, the commercial real estate market has been relatively stable in most parts of the country

HedgeWorld: But aren’t your clients frightened by the headlines?

Adam Tantleff: Investors are attracted to the steadiness of our returns. Since we launched we never had a down month and make roughly 1% to1.5% every month. We don’t make 20%-25% but neither do we go down 5% a month. Our portfolio consists primarily of income producing assets, which are the safest type of property. In recent months both existing and new investors put money into the fund.

HedgeWorld: This is not like a typical hedge fund. How do your clients do due diligence?

Adam Tantleff: We’re a business housed in a hedge fund structure. There’s the fund and there is the business of originating and servicing deals. Investors evaluate the business and how it works. And they assess how we run the fund, the risk parameters in place, how we value the positions in the portfolio. We give more than average transparency compared to other funds.

HedgeWorld: What does next year look like?

Josh Zegen: We hope to double our deal volume in 2008. We're actively recruiting – it’s a great time to pick up talent from the investment banks.

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