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REIT Is Seeking $1 Billion for a Private-Equity Fund That Will Focus on New York and Washington

By ANTON TROIANOVSKI of the Wall Street Journal

Vornado Realty Trust, one of the biggest real-estate investment trusts in the U.S., is seeking to raise $1 billion for a private-equity fund to invest in the wave of distressed properties expected to hit in the next few years.

The move signals that Vornado, which has one of the industry's most respected management teams, believes it can raise equity more cheaply from private investors than in the public market. But the company, long a darling of investors, risks dismaying shareholders who hoped Vornado would use its investing expertise to do deals on its own balance sheet.

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Vornado Realty Trust owns the space formerly occupied by the Virgin Megastore in Times Square in New York City, shown here in January.

Vornado says the proposed fund, Vornado Capital Partners LP, would be the company's "exclusive vehicle for real-estate and real-estate-related investments," according to a presentation to potential investors that was reviewed by The Wall Street Journal. In the presentation, Vornado said the fund would aim to generate returns of over 20% by taking advantage of distress in the real-estate market. Vornado would focus on the areas it knows best -- office and retail properties in New York and Washington.

The company would provide 20% of the capital in the fund. That means Vornado would generate management fees and a big chunk of any profits. But if Vornado hits a home run, much of the profit would go to private investors like pension funds and endowments, as opposed to Vornado's common shareholders.

"This has long been a company that has created an awful lot of value by taking advantage of opportunities on its own balance sheet," said Green Street Advisors analyst Mike Kirby. "If you're bringing in outside partners, granted you can make outsize fees, but the challenge will be convincing [shareholders] that those fees are as lucrative as the opportunities themselves."

For Vornado Chairman Steven Roth and Chief Executive Michael Fascitelli, the fund is a chance to do more of the bottom-market deals that made the company successful after previous downturns. In the early 1990s, Mr. Roth made a bet on Alexander's, a bankrupt Manhattan retailer, that paid off years later when the Bloomberg LP headquarters was built on Alexander's land. And in 1997, Vornado got a foothold in the Manhattan office market by buying stakes in seven office buildings for $700 million. Messrs. Roth and Fascitelli declined to comment on the proposed fund.

Some analysts believe other bargains will emerge as real-estate deals completed at the top of the market return to the market, at much cheaper prices. On Friday, a partnership led by developer George Comfort & Sons agreed to buy Worldwide Plaza in Manhattan from Deutsche Bank for about $600 million. According to Real Capital Analytics, the building was purchased in 2007 for $1.74 billion by developer Harry Macklowe. Unable to refinance short-term debt, Mr. Macklowe handed back control of Worldwide and six other Manhattan skyscrapers to lenders led by Deutsche Bank.

Analysts believe Vornado is well positioned to ride out the commercial real-estate downturn. The company played defense by raising $710 million through a stock offering in April.

In all, REITs raised some $13 billion in the stock market this spring. Much went to pay down loans, but analysts and REIT executives have said they expect REITs to continue raising capital in the public market to buy properties from distressed landlords. "Most smart observers feel like the cheapest capital for the next few years is going to be in the public market, not the private market," Mr. Kirby said.

Vornado's move appears to counter that view. To go on the offense, the company will try to tap private investors, a tall order in today's market. "Vornado has some marquee strength because of the people," said Geoffrey Dohrmann, who heads Institutional Real Estate Inc., an industry consulting firm. But "a lot of folks are feeling that while there are going to be tremendous opportunities, they haven't unfolded in wholesale fashion yet, and there's no penalty for waiting."

Some REITs, such as warehouse owners ProLogis and AMB Property Corp., have run private funds for years. They often have focused on properties that the REIT itself develops. Vornado's fund would have a broader mandate, and it is structured like a classic real-estate "opportunity fund" that seeks out good buys across regions and property types.

Mr. Dohrmann said some institutional investors, notably sovereign-wealth funds and a few large endowments, still have money to invest. And he argued that an opportunity fund is the best structure to invest in distressed real estate, which may not generate cash flow for years.

Yet Vornado faces a tough fund-raising environment. Many pension funds and endowments doubled down on highly leveraged real-estate "opportunity funds" during this decade's boom. Those are now posting dismal returns, leaving many institutional investors skittish.

Michael Restuccia, chairman of the San Joaquin County Employees' Retirement Association in California, said the pension fund isn't looking to commit new money to real estate. The fund had $136 million invested in real estate at the end of 2008, and Mr. Restuccia isn't happy with the results. "I'm very disappointed with all of these real-estate funds," he said. "I'm not so sure that I have enough confidence that somebody's going to be able to go out there and convince me that they're getting such a great buy."

In deciding to focus on properties in Washington and New York, Vornado has picked two markets that tend to be resilient over the long term, but are performing very differently in the current recession. The Washington office market in the past year has held up better than in most U.S. metropolitan areas, according to research firm Reis Inc. Average rents there rose 0.9% in the past 12 months. New York, meanwhile, saw a 14.9% decline in rents, worse than any other office market in the country.

Write to Anton Troianovski at anton.troianovski@wsj.com