Morgan Stanley Loses $5.4B In RE Fund: Biggest Loss In History!

Econophile's picture

From The Daily Capitalist

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.

There's not much Morgan Stanley can say about this other than mea culpa. It appears they are having trouble raising money for Msref VII.

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.

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tupac shakur's picture

Well, the $5+ billion is only from the current fund. As reported in June 2009, Morgan Stanley is in the process of losing a lot more money - writing down 80% of the properties in Fund V U.S. and 60% in Fund VI International

Itsalie's picture

This is not Morgan Stanley losing its own money, its the real estate fund that Morgan Stanley manages that lost the money, aka investors like US pension funds, and the usual overseas sovereign wealth funds, "suspects" like the xIC (where "x" could be anything from A to Z, passing by C and G"). As stated in the article, MS itself earned hundreds of millions of arranger fees and management fee approx 1.5% p.a (ie approx $135m a year). So for once, the US taxpayers are not on the hook for this folks, rejoice!!

On a separate note, investors should really consider legal action against the fund manager MS, in 2007 it was widely known the Japanese banks and property zombies were desperate to offload commercial real estate, which was already sick for nearly 30 years. Yet we still find supposedly "savvy" real estate fund managers plonking over $3b (before leverage), and getting less than 10% back.


And that brings us to today, where all the institutional investors (including without any doubt the "xIC", the Calpers and Yale/Harvard of the world) all lining up for .... guess what ..... US junk bonds and LBO refis are flying off the door faster than the European investment banks can package them, same old shit of covenant-lites and PIKs terms etc. And anyone thinks the S&P are at ridiculous levels, take this: all high yield indices are at historical record low spreads every passing day, witness the HG14, JNK, Bloomberg HY index etc, all at historical records.


Sure it is Ben, and Tim, but it's also greed and dumb money chasing yield.

malek's picture

When I first read the headline, I thought: $5 billion more burned somewhere, so what?

But the bigger point only was pointed out at WSJ: "Morgan Stanley has told investors in its $8.8 billion real-estate fund that it may lose nearly two-thirds of its money from bum property investments."


Carl Spackler's picture

Thank God we have the SEC there to -ahem- regulate Morgan Stanley.

Yet another case of too big and failing.

tupac shakur's picture

Looks like the ex-MS Real Estate guys - largely responsible for losing billions - are starting a new platform to repeat their success

Marvin_M's picture

as a survivor of 3 housing bubbles in CA since the early 70s - having ridden out the first 2 and bailing out ahead of the final burst in 2005 - it is satisfying somehow to watch how this madness can play itself out on a grand scale.  Buying into commercial real estate or any real estate  (except maybe China) in 2007 is indeed stupidity writ large.  Observing how these shysters wiggle trying to unwind their positions, even walking away, is gratifying indeed... If the government even looks like they might lend a hand to cushion the fall, there will be riots in the streets.

captain sunshine's picture

There will be no riots, you peasants will take it hard and dry.

jt's picture

Handle with care:  I have not laid eyes on the word danegeld in thirty-eight years.  Not since freshman year European History.  I love the contributors here.  Truly an erudite and literate bunch.

verum quod lies's picture

Daily Capitalist:

You stated: "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." Bingo, you win a stuffed toy of your choice (i.e., what you see on the wall). In fact, most, if not all option models that are used by folks like Morgan Stanley, largely ignore macroeconomic risk (to the extent it is included, it is impicitely included in the usually assumed normal/Guassian distribution(s)). Thinking about, let alone modeling, things like recessionary business environments or waves of defaults is just not part of what is done (for at least two reasons: (1) modelers are flat out told not to, or can't mathematically do it, and/or (2) it would stop the deal or trade from getting done). One must remember, the longest time horizon for people who work at these places tends to be 365 days (i.e., on January 1st each year, ignoring a leap year) or an average horizon of half that (half a year), yet they invest in things that can have effective lives in the decades (e.g., the real estate deals/projects that you mention as having been their undoing). In addition, as you mentioned, there can be conflicts of interest. Anyways, while an impressive record, and hats off to Morgan Stanley, we shouldn't be too surprised, as the incentives and personnel alone are the likley drivers of such a record level of incompetence.


twotraps's picture

Love it, the bank is trying to negotiate with other banks to re-do the the rest of the country!  Hope they throw their asses out and take the keys to Eurotower.

Handle with care's picture

Can see why they need to pay the big bonuses to retain this talent.

If geniuses like this were lost to the financial industry and left for other sectors of the economy we really will all be fucked.

Perhaps we should look at the bonuses as danegeld that we all pay to keep them out of the real economy

Econophile's picture

I like the Danegeld idea. Put them on an island, say Hawaii and let them play golf.

williambanzai7's picture

Is this how a so called blue chip Wall Street investment house is supposed to behave? Of course!

Privatus's picture

It's not all bad news. The sellers of properties to the fund made out like bandits.

Number 156's picture

Maybe they see every other large firm getting a wad of cash shoved down their throats from the government, and were hoping if they could throw good money after bad and get the same. Its a little something called moral hazard.

dumpster's picture

just put the loss off balance sheet . pretend the property is worth what they say it will be in thirty years

whats so bad about those apples .


Keyser Soze's picture

It really sounds like the bankers at MS are working exceptionally hard to un-fuck the deal up. They deserve maximum bonuses, really.

Reggie Middleton's picture

I actually wrote two lengthy articles about Morgan Stanley's RE performance last year. The first detailing how it was not that difficult to see that they were investing at the top of a bubble, and the second showing that they had every economic incentive (fees) to invest at the top of a bubble since the client fees insulated them against loss - in nearly every potential scenario. Click the following links (in the second article, you can even download a model to see how much you are getting bilked by GP fees):

A look at the Morgan Stanley CRE ventures and lesson based on what happens when you buy into a bubble: Doesn't Morgan Stanley Read My Blog?”. Of course you can afford to buy into a bubble when your clients subsidize most of your CRE losses with a permanent, premium free call option: Wall Street is Back to Paying Big Bonuses. Are You Sharing in this New Found Prosperity?

  • The huge difference between the returns of GP and LPs and the factors behind this disconnect reinforces the conflict of interest between the fund managers and the investors in the fund.



Menelaus's picture

Reggie, how about an analysis of Blackstone's ill advised acquisition of Hilton Hotels by the "genius" Jonathan Gray?

Econophile's picture

Thanks, Reggie. I do read your stuff and enjoy it. I think the question is, why did they do that? Why did they construct deals that front load huge fees? I think the answer is obvious as you point out. But that is human nature and we've got to assume that everyone in the investment world is "greedy." So let's go back one step and ask more basic questions.

Why did the promoters and investors of these deals fail to see the obvious? I think it is faulty economic analysis and faulty risk analysis endemic on the Street. As you and most readers probably know, I would tie this all back to Keynesian-econometric mechanistic views of the world as to economic analysis and herd behavior as to risk analysis. That's why everyone missed the obvious and continue to do so.

BTW, my very first article in 2007 was about subprime investment structures. Also, my business has been real estate investments, and I thought your analysis was excellent.

Thanks for the comment.

Carl Spackler's picture

Reggie, I admire your work and motivation to get at the truth...assuming the numbers are fairly presented, as opposed to Erin Callan's numbers - OH!

Your voice of reason and responsibility is refreshing in this era of nonfeasance and shirking responsibility.



alien-IQ's picture

Reggie you do great work and it's always wonderfully detailed.

That appears that not even the largest RE loss in history is enough to cause so much as a down tick in the MS stock...or any other stock for that matter.

Obviously...we've either run out of Red Pills...or everybody has opted for the Blue ones.

How this news doesn't move MS stock down is just...astounding.

Leo Kolivakis's picture

If you smooth the valuations over 30 years, they come out ahead!

Leo Kolivakis's picture

Reggie, good stuff, too bad dumb public pension funds aren't listening!

Problem Is's picture

Reggie... the man with the facts... I admire your work.

alien-IQ's picture

Market should pop on this news...particularly REIT's and Banks...naturally.

No doubt CNBC will spin this real pretty.

on the other an outside gamble...the $25 puts might be interesting...but in this market, that would be a total daredevil move...

cplusplusandloathing's picture

No risk, no reward...Besides, if you buy puts nobody can recall your shares!

whatsinaname's picture

check out how the prison population has soared since 1971 (graph available at wikipedia). Apparently the move away from gold standard and easy money does not equal good values and quality of life !!

jeff montanye's picture

the average working person's real (inflation adjusted) hourly wage peaked in 1973.  

BlackBeard's picture

The politicos started the "get tough on crime" campaign in the early 70s.  It just meant bloated judicial and enforcement budgets, lengthier sentences and more people going to jail.  No proof that move from gold standard caused this increase in prison population. sorry bud.