Distressed Investing Is in BH3’s DNA
BH3 Management earned its stripes and built out its portfolio during the GFC, now it's stepping in to offer savvy solutions during this downturn.
By Cathy Cunningham January 3, 2024 10:46 am
reprints
Baggage Handler (n): a person who loads and unloads baggage.
In the hairiest of markets, very few succeed. Those who do thrive tend to have some solid, hard-earned experience in their back pockets that helps them identify, quantify and act on opportunity when it comes their way.
Take, for example, Fort Lauderdale-based investment firm BH3 Management.
If the name sounds familiar, it’s because BH3 has closed numerous headline-grabbing deals over the years. Investing up and down the capital stack and targeting opportunities in debt, development, joint venture partnerships and opportunistic strategies, its debt and opportunistic equity and development investments include, among others, The Raleigh hotel, Watson Island, Privé at Island Estates, Trump Hollywood and Icon Las Olas, all in South Florida, and the 88-story residential skyscraper 125 Greenwich Street in New York City.
Distressed investing is in the firm’s DNA, and while the commercial real estate industry prepares for further bumpiness and portfolio shakeouts in early 2024, BH3 is ready to do what it does best: find market opportunity while creating solutions.
“We’re uniquely positioned because we’re set up to be countercyclical,” Greg Freedman, co-founder and co-CEO at BH3, said. “We’re not a fund with one mandate that can only invest in one part of the capital stack. Throughout our 14-year history, we’ve played in every single piece of it.”
As such, BH3 has been preparing for the opportunity window at the end of this cycle since the firm got its start at the end of the last one, capitalizing on distress coming out of the Global Financial Crisis (GFC). “Where we’re seeing the world go now is where we thought it actually would have gone a bit earlier,” said Daniel Lebensohn, also a BH3 co-founder and co-CEO.
Indeed, our industry has been through enough hard knocks to give Orphan Annie a run for her money these past few years, with some borrowers holding onto troubled assets for dear life or kicking portfolio distress down the road in the hope that the sun will indeed come out tomorrow. But, at some point, something’s gotta give. Real estate is a cyclical asset class that ebbs and flows relative to the cost of capital, and while that cost was near zero for quite some time, it hasn’t been near zero for 18 months now.
Enter distress, stage right.
“In any cycle, there’s opportunity, and, as a firm, we’re known for getting between the wall and the wallpaper,” Freedman said. “For us, there’s an incredibly exciting opportunity on the credit side right now, because spreads have gapped out and there’s less competition on the financing side. There’s also going to be real opportunity on the equity side when there’s capitulation. We haven’t seen that yet, but we’re seeing cracks.”
Banking on opportunity
Lebensohn describes the current debt opportunity as a para-digm shift that’s evolved over time, buoyed by money-center banks pulling back and the regional banking crisis.
“Banks have re-created their identities and tightened their belts to become hyper-conservative,” Lebensohn said. “That hasn’t changed the fact that there’s a myriad of innovators and entrepreneurs out there that want to put money to work who also need leverage to make the numbers make sense.”
As a result, BH3 has seen a huge inflow of financing requests for development projects at various stages of completion. “It’s hedge funds and [private equity] shops — shops like us — that have funds ready to deploy for that,” Lebensohn said. “The landscape has changed, and it’s really only the alternative lenders that want to play today.”
Up until the end of 2022, it was middle-market debt funds and brokers showing BH3 deal flow. Today, it’s big debt funds and private equity groups — who Freedman describes as household names — inundating BH3, with borrowers also showing the firm deals directly: “They see the transactions that we’ve done or structured ourselves, and our special sauce of being credit experts on the one side, paired with our development expertise and our DNA in distress,” Freedman said.
That double helix means the firm not only understands complex situations, it’s drawn to them like a moth to a flame ( if that moth had a tiny fire extinguisher under its hairy wing).
“We think that’s where we create and add the most value,” Freedman said.
On the credit side, they’re also fielding myriad calls today, from borrowers struggling to secure refinancings, to lenders walking away from deals at the 11th hour, to the need for some cold, hard truths.
“What we’re doing on a few deals in our pipeline right now is re-engineering what that structure should be, and going back to the borrower and saying, ‘Listen, this is where the capital markets are, and your ask — as is — not does not exist. This is what the structure should look like,’ ” Freedman said.
Perhaps unsurprisingly, a typical deal fix today in some of those tricky situations “is called an equity check,” Lebensohn said and laughed.
BH3’s development experience also comes into play should business plans need tweaking. The firm recently looked at a two-tower financing deal, where one tower was condos and the other intended to be multifamily. “Our guidance to that borrower was that the second tower should be condo, because it would reduce the amount of required equity [due to the addition of condo deposits] and put the construction loan at a lower attachment point, so they’d get better pricing,” Lebensohn said.
Not every lender would encourage their borrower to change their business plan to facilitate a loan, of course. “It’s just not par for the course,” Freedman said. “But in this environment, borrowers need lenders who comprehend their challenges, and what the solutions might be.”
Do you work out?
BH3’s heightened proficiency in the current season of market Hunger Games comes down to its start in distressed investing, which began during the GFC.
“We started in workouts,” Freedman said. “We were buying complex deals that were essentially hornets’ nests.”
Before BH3 started, well, buzzing, Lebensohn was working as an attorney while Freedman was a bridge lender.
“In the early days of the credit crisis, I quickly realized that I was on the wrong side of the business because the opportunity at that time was to buy up distress,” Freedman said.
At the time, Lebensohn was located in New York, where he had a joint venture with a credit hedge fund named Archer Capital. The person who introduced him to Freedman in 2008 was Eric Edidin — now a partner and executive chairman of BH3 — who ran that hedge fund.
Neither Lebensohn nor Freedman come from wealthy families or real estate dynasties, but they shared some common traits. “We’re both scrappers with a ‘Get it done’ mentality,” Freedman said.
The two hit it off immediately.
“We were supposed to be together for an hour, but were together for three,” Freedman recalled. “Daniel went back to New York, and a couple months later he was back in Miami. He called me, saying he was looking at a deal.”
As it happened, Lebensohn and Freedman were looking at the same deal.
Between them, they had good relationships with the developer, architect and bank. A new partnership was born, and their first deal on Terra Beachside, a 117-unit condo project in Miami, was executed.
Fast forward to today, and BH3 is 29 people between Florida, New York and Denver. “The whole firm started really without any intention of being a firm,” Freedman said. “It was two guys coming together saying, ‘Hey, why don’t we try to figure it out?’ And we’ve been figuring it out year over year, although we had a lot less gray hair back then.”
That may be so, but with gray hair comes the in-the-trenches experience that several others don’t have today.
“When you’re talking about difficult capital markets, today pales in comparison to what was going on [in the GFC],” Lebensohn said. “All the cranes were stopped, and you had to be a pugilist and fight to find your equity, let alone your debt.”
The two took some punches on the Terra Beachside deal, but it also led to their name.
“We were on Greg’s GoToMyPC,” Lebensohn recalled (“This story requires some humility on my part,” Freedman chimes in.) “I was in New York, he was in Florida, and we were on the call with [deal parties], going over the terms of the deal. When they dropped the bomb on us as to what they thought the terms might be, fire started coming out of my ears.”
He instant-messaged Freedman, and his words instantly appeared on Freedman’s computer screen — the one everyone in Miami was looking at: “What do these guys think we are?! Baggage handlers?!”
Freedman started flipping out.
“They can see my screen!” he texted Lebensohn. “Stop sending messages!”
The drama proved fortuitous. After the parties agreed to the terms of that deal, Freedman asked his partner, “What’d you want to call the company, because we need a special purpose vehicle [SPV] for the deal?”
“Well, why don’t we call it Baggage Handlers Three?” Lebensohn replied.
The name has followed them since.
“Every time I’m on a plane and someone needs help with their luggage, their eyes somehow go straight to me,” Freedman said.
With a name established, the new firm was quickly off to the races with a relentless appetite for deals. The next transaction was the purchase of Trump Hollywood’s senior and mezzanine debt. From 2009 to 2012 — without any committed capital and every deal being done via an SPV — BH3 did “some real damage in a great way,” Freedman said. The firm closed deals on Terra Beachside, Trump Hollywood, 1805 Ponce de Leon in Coral Gables and a package of multifamily buildings in New York City. They also bought several loans — and got paid off on them — and Lebensohn moved to Miami.
They signed the papers with Terra Beachside “on the hood of Greg’s old Ford Explorer in November 2009 [“It was a Ford Expedition,” Freedman corrected], while I was looking for a house to rent,” Lebensohn said.
As for the man who facilitated that initial meet-cute, Edidin’s firm funded a number of BH3’s early deals, and he continued to be an investor in the firm, until he retired from the hedge fund business and Freedman asked him to join BH3 as executive chairman to help as he and Lebensohn institutionalized the firm in 2020.
When the GFC distressed buying opportunities dried up, the BH3 founders fell “ass backwards” into the from-the-ground-up development business, Freedman said.
They had taken over other projects previously, but in 2013 they signed a deal to do their first ground-up development deal, Privé at Island Estates. Not doing things by halves, it spanned 1.3 million gross square feet on an 8-acre island off Williams Island in Aventura, Fla., and features twin 16-story towers with 80 residences.
“We’re big thinkers and believers in ourselves, but, equally importantly, the team that we surround ourselves with, which has delivered some of the biggest, most magnificent projects in South Florida,” Lebensohn said.
You’ve got a friend in 3
Commercial real estate is a relationship business, and BH3 has worked diligently to make friends rather than enemies through its opportunistic investments.
“Daniel and Greg are brilliant, but they’re also just great people to do business with,” Edidin said. “Relationships come first, and the firm has a very long-term focus in terms of building relationships and doing right by people.”
Charlie Sieger and Jose Suarez’s firm, Sieger Suarez Architects, was the original developer and architect for Terra Beachside. They ultimately got caught in the GFC, and BH3 foreclosed. But instead of steamrolling the firm or going after their guarantees, BH3 built a rapport with Sieger Suarez, bringing them into the fold on the deal.
“Fast forward, they’re now the architects for Privé, they’re business peers and friends for the entirety of this company’s existence,” Lebensohn said, adding: “We have multiple experiences like that.”
Another is Trump Hollywood, where George Perez from Related Group was the borrower when BH3 bought the senior loan from HSBC and the mezzanine debt from Lehman Brothers. “We were taking over control,” Lebensohn said. “But we did it in such a way that we became partners and friends. Fast forward, we ended up buying 50 percent of [Related’s] Icon Las Olas [the tallest tower in Fort Lauderdale, with 40 stories of luxury rental residences], and we’ve co-invested on other credit opportunities.”
BH3 2.0
At the end of 2017, with Privé nearing completion, Freedman and Lebensohn started mapping out the firm’s next iteration. They had a thesis that interest rates had to go up, and saw that equity prices were getting pretty frothy.
With a track record now established, they thought it was time they had committed capital behind them so they could be more opportunistic in their investments. And that’s exactly what they did in 2018, when they launched their first debt fund— the goal being to act quickly when opportunities unfolded, and not have to scramble to raise capital.
They also realized there was a new host of bridge lenders in the industry who hadn’t yet experienced down cycles like they had.
“They didn’t necessarily need our capital, but they certainly were not opposed to having us behind the scenes as partners in A/B structures on whole loans,” Lebensohn said. “So, in an effort to deploy capital, and recognizing that we could get outsized returns there — while also being in an interesting fulcrum position if something went bad — we had the ability to service a loan, right the ship on the collateral, and/or work with the borrower. That was a place that suited us very well.”
In that first fund, which was around $50 million, BH3 deployed $300 million on deals — including buying the nonperforming debt on 125 Greenwich Street in New York in 2019. Fortress Investment Group ended up buying out BH3 on that investment for $230 million seven months later, and roughly two weeks before the pandemic started.
“[125 Greenwich] was really the singular distress piece in Debt Opportunity Fund One,” Lebensohn said. “Predominantly, we started crafting these A/B structures with best-in-class bridge lenders, and that proved to be a successful path for us and led to a refinement of Debt Fund One into Debt Fund Two — which is now in the the middle stage of raising its capital, but has also been deploying capital since February.”
Around the time of the 125 Greenwich deal, Edidin joined the founders as a third partner in the firm.
“We’ve been friends and partners for multiple decades, and our careers and our lives have become intertwined,” Edidin said. “There’s a level of trust and experience together, which makes it an ideal partnership.”
Edidin is also a restructuring expert, and his three-decade career has focused on corporate and real estate credit and distress. In fact, his first project when he worked for Blackstone was the Olympia & York’s restructuring in 1992, involving more than $20 billion in debt and ranking as one of the largest ever of a private company at the time. From there, he co-founded the credit group at York Capital in 2000 before forming Archer Capital in the JV with Lebensohn.
“My view is that our firm has a real advantage, in terms of all of its strategies reinforcing each other,” he said. “As a result, we’re able to operate in each of our strategies with less risk, and more knowledge coming in.”
Game, (opportunity) set, match
When BH3 bought the debt on 125 Greenwich, they were one of the very few groups buying distressed deals of size. Today, they’re picking their spots.
“We’re geared up and ready,” Lebensohn said. “We look at distress every day — but we’re very focused on downside protection and a lot of it still doesn’t make sense for us yet.”
Chances are the number of opportunities will only increase as we head into 2024, however. Despite the Fed throwing the market a bone in mid-December, there’s still $1.6 trillion in commercial mortgages coming due over the next 12 to 24 months, and the cost of capital remains high for now. The firm isn’t just chasing any old deal, though.
“We hate losing a lot more than we like winning, which is why we’ve never had a single principal loss on any credit deal we’ve done in the history of the firm, which is now 112 deals,” Lebensohn said. “We don’t lose sleep over the deals that we missed that could have been good deals. We’re just very cautious about picking our spots, and patient.”
While being patient waiting for some deals, BH3 is also plugging away at some blockbuster, slow-burner ones. It recently teamed up with Merrimac Ventures to redevelop 10.7 acres of land on South Florida’s Watson Island into hotel, retail and residential uses in addition to public space and a waterfront promenade.
“It’s quite an undertaking,” Lebensohn said. “It’s very much a collaboration with the municipality, and we think that it matches perfectly with the evolution of Miami.”
It’s also BH3’s first deal with Miami powerhouse firm Merrimac.
“Nitin and Dev [Motwani] have been friends for a decade-plus,” Freedman said. “We always wanted to do something together, we were just waiting for the right opportunity, both in size and where our unique skill sets were complementary to each other. There couldn’t be a better deal to come together on than this with their background in hospitality, and Miami Worldcenter.”
Not bad for a few baggage handlers.
