It is no secret that armies of fund managers are on the hunt for distressed real estate and struggling mortgage investors. Against that backdrop, the performance of institutional real estate investors is being closely watched. Market analysts are working overtime to quantify the likelihood that any given player will become weak enough on any given day to begin of distress selling.

Opportunistic investors are scrutinizing the recent performance of real estate investment trusts, for instance. Why REITs? Both property and mortgage REITs represent the purest play that gives savvy investors the chance to scoop up the assets through distress sales. REITs — particularly some vulnerable ones in Japan and Western Europe — are beginning to show signs of stress.

However, it is the swift and decisive work of asset managers that can prevent this scenario from happening. The role of the asset manager is to monitor and, if necessary, seize control in the event the real estate cash flow does not meet its debt obligations. Given their substantial holdings, REITs rely heavily on asset managers to come up with solutions ahead of loans coming due.

Opportunity amid volatility

After the recent collapse in commercial mortgage-backed securities, REITs and real estate investment funds appeared to be attractive alternatives to complex CMBS bonds. But volatility has made them vulnerable.

From January through May 2008, the benchmark FTSE NAREIT All REIT Index from the National Association of Real Estate Investment Trusts rose 6.46%, dropped a stunning 11.2% in June, and was showing a gain of about 2.8% by late July.

So what are opportunity investors hoping to gain from this trend, and to put all their sidelined money to work in real estate? The simple answer is that they are hoping for a refinancing crisis. Private equity funds are on track to raise more investment capital in 2008 than ever before. In the first half of this year, private equity funds raised $40.2 billion, well on pace to top the $74 billion raised in all of last year, according to proprietary research data from PrivateEquityRealEstate.com.

The property owners who have been able to refinance in this credit cycle have done so, while those that have not have been forced to sell. A case in point was the Macklowe Group's recent failed attempt to refinance two short-term loans — a $1.35 billion loan from Fortress Investment Group and a $5.8 billion from Deutsche Bank for its massive New York City portfolio that included the trophy General Motors Building. Because of the group's refinancing crisis, it was forced to prematurely sell out to Boston Properties Group.

Invaluable asset managers

Institutional investors have been shoring up their asset management capabilities since the market for collateralized debt obligations collapsed last year, recruiting the managers who became free agents from the displacement. To be sure, at the peak of the CMBS and CDO run, the value of an issuance was measured by the value of the asset manager behind the deal. Today, investors who don't have capable asset managers on hand are more likely to encounter a refinancing wall and be in need of an exit strategy.

In the coming weeks and months, look for more real estate investors like REITs to announce they are conducting a “strategic review” of their properties and mortgage assets. That is usually code for bumping up against distress situations and seeking exit strategies before something like a refinancing crisis occurs. So far, investors have been able to refinance some transactions, and there are fewer such deals waiting in the queue through the end of this year.

If distress investors are looking for a refi crisis, the signs are not very good. Asset managers are known to have relationships with enough deep pockets such as B-note buyers and special servicers, who can step in as a white knight and head off a fire sale of quality assets.

While some REITs appear vulnerable, any strategic review of an investment portfolio will have the asset manager at center stage, with strategic alternatives in hand. That's another way of saying a major asset trade or an outright corporate buyout may be imminent.

W. Joseph Caton is managing director of Oxford, Conn.-based Hartford One Group, a real estate finance consultant.