The US CMBS delinquency rate fell in November to its lowest point since February 2009, according to Fitch Ratings. The decline was driven by strong new issuance activity.CMBS DQs at nearly 10-year low — Fitch
“It’s a strategy that involves far more than one-note purchases, you could say about the business plan of New York-based Somera Road Inc. and it’s making some sweet music for its investors.”
“[Screw] funds,” Somera Road principal and founder Ian Ross told Commercial Observer earlier this year when asked whether he’d ever want to start one. “I don’t want to have to fit these deals into a box. We might have a $1.8 million deal or a $108 million deal.”
“These deals” have turned his 3-year-old firm into a heralded, but rather inconspicuous, private equity real estate shop deploying what sources told CO is a “clean playbook of perfect execution” on off-market, distressed CMBS real estate opportunities across the country.
In the years since its first deal in the summer of 2016 — the purchase of the 3Y Building, an office tower just north of downtown Kansas City — Somera Road has sourced and executed on 66 distressed deals at a valuation of over $1.5 billion across 49 markets and nearly half of the continental United States.
Ross started the company out of his Manhattan apartment in the summer of 2016 and has since grown the team to 15 professionals, who punch above their weight and successfully execute and asset-manage across the firm’s unbelievably large footprint.
“Oh boy, do they know how to work a deal,” the managing partner of a global hedge fund exasperatedly told CO, on the condition of anonymity because the manager is in the process of raising a new fund.
Ross, a former financier, doesn’t take himself too seriously, which is somewhat of an antithesis to the way he runs his business. He’s a 33-year-old commercial real estate “junkie” from Los Angeles, who said he’s only as good as the sum of the parts of his company — he works within a climate of “radical transparency.”
“The amount of deals that he’s closed, executed — in terms of the business plan — sold, stabilized and refinanced, it’s nothing short of a miracle in the world we live in,” Tim Dunn, the chairman of Kansas City-based JE Dunn Construction, told CO. Dunn said they’ve worked on around 15 deals with Somera, including its first, the 3Y Building.
While Somera is headquartered in New York, you’ll find their footprint in places like Allentown, Pa.; Athens, Ga.; Huntsville, Ala.; Tulsa, Okla.; Memphis and Cleveland. Some of the firm’s most high-profile deals to date have been in Memphis, Kansas City, St. Louis and Pittsburgh.
The walls of Somera’s office at 130 West 42nd Street in the belly of Times Square are adorned with mementos and sports memorabilia his team has collected from their work in the secondary and tertiary markets where they target distressed real estate. In his conference room are framed news clippings from Memphis, Tenn.’s The Commercial Appeal that show him shaking hands with local and state officials as well as FedEx Logistics executives after sealing arguably his most high-profile deal to date: a lease with Memphis-based global enterprise FedEx Logistics at the Gibson Guitar Building, a former guitar manufacturing facility located a block south of Downtown Memphis. FedEx Logistics CEO Richard Smith is planning an adaptive reuse of the property into an office hub to serve as the global headquarters for the company, which decided to move to the area to attract young talent and help spur a revitalization of the city’s downtown.
Next to the framed Commercial Appeal news clips is a Gibson guitar that Ross was gifted by his team following the closing of the FedEx deal. Ross had gifted Smith the same guitar, donning FedEx purple and orange, at the ribbon cutting in February; it was the last one manufactured at the location.
Somera (Ross named his company after the road on which he grew up in Los Angeles) has perfected a strategy of finding distressed assets in special servicing via commercial mortgage-backed securities (CMBS) trusts. It trades in distressed CMBS credit, buying and using the rights of the controlling bondholder to pull out and work out deals. They buy, execute, stabilize, monetize and repeat, aiming at smaller deals that are typically bypassed by larger institutional firms.
“His approach to how he finds assets and the ways he’s gone about doing it has been a very overlooked strategy by most,” said Matthew Philip, the head of commercial lending at Bayview Asset Management. “Going into CMBS trusts, looking for things from special servicers and really understanding what’s going on in those legacy deals, is textbook. [They] find where the distress is and take advantage of the opportunity, while being smart about what’s presented to [them]. To some extent, the complexity of pulling assets out of the trust, seeing that the distress isn’t always related to the specific asset but to the structure that’s behind it, is the genius in the approach. I don’t think a lot of developers have seen that opportunity that exists, especially with the smaller assets.”
Ross seemingly amazes those who transact with him. He has found a happy medium living under the realm of a major institutional investor but above the fray of a single-family office. He “runs his team hot, with a shock-and-awe approach,” the global hedge fund manager said. “He always beats his base case and is conservative by design.”
The firm has found a sweet spot in being sub-institutional, but Ross and Somera have to make up for that in volume, which they’ve proved is no issue, according to sources who spoke to CO.
The global hedge fund manager, who’s invested in a handful of Somera’s deals in the last year or so, said, “[Ross] knows that if he goes above a $20 or $30 million equity check, he’s up against a Blackstone, and things get ugly quickly … a $5 or $10 million check size on his management fee [nets them] probably [$500,000] or a million bucks a year. It’s nothing, but he’s just doing so many of them. It’s hard to compete with him. You have to be able to get messy with him on $5 [million] to $20 million deals. For a lot of people, it’s just not worth it. For him, it’s because he is trying to compound at very high rates of return, not collect a management fee.”
Somera works unbelievably fast in all aspects of its business and has on numerous occasions found a buyer for a project before even closing on its purchase. Out of the deals he’s done, “[many of them] never even made it to market, because he had already done what he had to do before he equitized them; that’s the speed this guy works at. It’s crazy,” the hedge fund manager said. “He’s sourced extremely well.”
Ross frequently challenges his newest or youngest employees by giving them free reign to run transactions — sometimes overseeing entire regions of the country — just to instill a level of trust and to see how they react to executing his firm’s playbook. That strategy hasn’t always panned out for the younger, less experienced employees, some of whom have felt overwhelmed and even left the firm. But Ross doesn’t care; where some failed, many have succeeded, becoming key members of his team. (Somera was named as one of Inc. Magazine’s Best Workplaces 2019.)
“His guys hustle,” said the global hedge fund manager. “They won’t last in his culture very long if they don’t move at a very fast speed.”
The fund manager said that when he was introduced to Ross and Somera just under a year ago, he deployed a diligence team into Ross’ ecosystem and pool of existing investors “to fully understand what he was doing, because quite candidly, he’s such an outlier, I wanted to make sure it was real.”
Ross is a staunch opponent to the idea of overextending his firm, shooting higher or becoming a “fund,” because he considers it a headache and a hindrance to his investment philosophy. He said his team views itself as “disintermediating what is often times an archaic fund model,” and he said becoming a fund “is against everything we are about. We like to stay nimble and flexible, and we want to be able to do deals of any size, asset class, geography or risk profile without them having to fit into a specific box or mandate.”
Per the hedge fund manager who spoke to CO anonymously: “if [Ross] overstretches his [firm], he’ll shatter it … he’s self-aware.”
“Listen, if I had the cojones, I’d have done the same thing,” Bayview’s Philip said. “Once you develop relationships with those servicers and you’ve executed a couple times, they’ll come back to you to sell the assets. You can figure this [method] out if you’ve got a little bit of savvy and an understanding of individual markets. The smaller deals lie under a lot of people’s radars. The [firms] with the big staff don’t want to spend time on all these $3 [million] or $4 million purchases of these defaulted assets, even though you can hit a bunch of home runs with them; they want to deal with the bigger stuff.”
For Ross and his team, basis is everything. In a yield-starved world, he has no qualms with walking away from an attractive investment if he doesn’t feel it meets the parameters of his game plan; he’s done it several times before, to the surprise of some of his investors. “His deal standards are so high,” the global hedge fund manager said, highlighting that Ross aims for a 25 to 30 internal rate of return (IRR). “He’s buying A-grade assets at B- or C-grade prices, hunting in a patch that’s messy — $5 [million] to $20 million deals. His returns in a very short period of time are extraordinary.”
But, getting the idea of Somera’s model across to investors in the company’s early stages wasn’t easy.
“Raising the first $5 million on our first deal is the hardest thing I’ve ever done,” Ross said. “I don’t take that for granted; it was extraordinarily challenging. But, you get the first deal done, and you build from there. We did our first deal in the summer of 2016. We did our second and third deals that November and December. And then I think we did [around] 26 deals in 2017. It was really kind of a snowball effect.”
In December 2017, Ross made his move on Memphis.
That month, Somera purchased guitar manufacturer Gibson’s real estate in Memphis and Nashville for around $32 million. The Memphis location — at 145 Lt. George W. Lee Avenue in the middle of the city’s Downtown — included what is a 150,000-square-foot factory and showroom and a nearby 350-space parking lot, where Ross is planning to develop a separate 350,000-square-foot office building called “The Clipper.” (The project is under development, Ross said, but before they started, he said Somera leased the parking lot to an operator—triple-net—who would run it for use during events and basketball games at the adjacent FedExForum). Ross and his partners explored other uses for the Gibson space, such as retail — for a grocery store — office or even a potential brewery, according to a 2017 letter sent by a legal representative of the investor group to the Center City Revenue Finance Corporation.
A few months later in the spring, Ross was approached by Billy Orgel and his son Benjamin — Memphis natives and community staples — who wanted to get involved, eventually taking a minority stake in the property and injecting Downtown development expertise and much-needed local backing.
Billy Orgel is the CEO and president of Tower Ventures, which develops wireless communications structures, and he sits on the Shelby County School board. His son Benjamin works for Memphis-based Slovis and Associates, a full-service commercial real estate firm; he’s also on the board of the Downtown Memphis Commission. The month that Ross bought the Gibson facility, the Orgels were wrapping up a conversion of the historic 19th century Tennessee Brewery in the city’s South Bluffs neighborhood — located just Southwest of Downtown, overlooking the Mississippi River — into a $42 million, mixed-use complex complete with multifamily rentals, office and retail space and a parking garage.
Around the time the Orgels entered Somera’s Gibson project, the newly formed FedEx Logistics’ CEO, Richard Smith, felt like planting a flag in Downtown Memphis.
“Strategically, it made a lot of sense to me,” said Smith, a Memphis native and son of billionaire FedEx founder Fred Smith. “It was kind of bringing the mountain to Muhammad, so to speak, in terms of where the talent is, so I was very interested in this.”
Smith got in front of the Orgels and learned of Ross.
“[Ross] brought on some people that really were well connected, particularly in the downtown market, which I think was a very, very smart move,” Smith said. “What struck me about Ian, at first, was he’s very young. But, I’ll tell you, he is a very sharp and dynamic businessman for his years. He was extremely passionate about Memphis and about the community. That spoke to me.”
Smith said Ross jumped at the idea to do Class A office space for a corporate headquarters. After some hesitation on the part of Smith to go forward with the plan, they picked it back up in December 2018 and haven’t looked back. The FedEx Logistics lease at the building will begin in April next year, the company has said. FedEx will expand the building from 154,000 square feet to just under 200,000 square feet.
Ross’ persistence and curiosity was bred from a young age.
Growing up, Ross’ parents instilled in him and his two brothers an unyielding ambition and an unwavering will to never stop learning, he said.
Ross’s father is an obstetrician, expert witness and a distinguished professor at UCLA medical school, and his mother is a counterterrorism consultant. His parents moved to Los Angeles from Boston when he was a kid, and he’s the middle brother of his two siblings. He’s married to a fellow entrepreneur: His wife started her own public relations business servicing the fashion industry.
“We use a twin desk at home,” Ross said. “She’s got hustle. I wouldn’t be here or have the motivation that I have without her.”
As an undergraduate, Ross attended Goizueta Business School at Emory University in Atlanta. He got his start in commercial real estate at Morgan Stanley in the summer of 2007, where he focused on originating and securitizing large, floating-rate CMBS loans, moving to an investment banking role at Jefferies & Company in December 2007.
In 2009, he saw an opportunity to join a newly formed family office called Triangle Capital.
“I came on and helped build that team, really, from day one,” Ross said. “It was myself and two senior partners — I was a junior partner and managing director [of acquisitions and asset management]. We built that team from three of us in a broom closet with a Bloomberg terminal into an 18-person operation.”
When Ross joined Triangle, they started focusing on buying distressed legacy CMBS credit at the bottom of the market.
“I always joke that when ‘The Big Short’ ends, we were the first scene of a sequel; we really came in at the bottom and started picking up the pieces,” Ross said. “From 2009 to 2013, there was a real arbitrage opportunity. CMBS is a more commoditized, yield-driven product; it was never supposed to be a credit product, because losses were never supposed to be severe. You have very few bricks-and-sticks guys in the CMBS space, and you had very few guys that understood CMBS in the real estate space, so if you could come in in 2009 and really understand the real estate, but also have access to the street, to buy CMBS CUSIP credit, there was a tremendous operational arbitrage.”
Ross identified his current investment philosophy at Triangle but was somewhat handcuffed by the institutional flavor of the shop. He wanted to asset manage and operate the real estate. (While at Triangle, he started his MBA at the Wharton School at the University of Pennsylvania, finishing it within six months after leaving in 2014.)
“You wouldn’t learn his kind of commercialism at a bank,” the global hedge fund manager said.
While a few of his investors said they were unsure of Somera’s ability to execute the same playbook in a downturn — “distressed assets in distress” — its track record will keep them interested.
“For lack of a better term, they’re shit kickers; they get shit done,” the global hedge fund manager added. “[Ross] is 33 and has the hallmarks of something pretty special. But, he’s just at the starting line.”
It’s a strategy that involves far more than one-note purchases, you could say about the business plan of New York-based Somera Road Inc. and it’s making some sweet music for its investors.
It was an approach that began with Somera Road focusing on distressed commercial building loans and properties from the 2008 recession, then expanded as the company discovered additional opportunities in midsized U.S. cities. Now the company is taking advantage of the 2017 changes to federal tax laws that have created economic opportunity zones as a method of spurring new investments in underserved areas across the U.S.
“At the outset we didn’t look at markets as much as we looked at assets first,” explains Somera Road General Counsel Michael Fralin. “We looked at hundreds of loans and then chose to invest in particular assets based on how the surrounding market was performing in the location.”
Long distance information, give me Memphis, Tennessee
Since 2015, Somera Road has bought more than 50 properties worth over $1.1 billion across 32 U.S. markets.
“Typically, we’re not buying buildings that are physically dilapidated or stressed,” Fralin, 44, says. “A lot were constructed during the real estate boom of the early 2000s, and the problem is they were saddled with too much debt, so they are financially distressed.”
In Memphis, where the heart of rock ‘n roll started beating, this approach took Somera Road to the Gibson Guitar Co. factory built in 1998 and within picking distance of Beale Street and B.B. King Boulevard. Beale Street is renowned as the center of the city’s blues scene and B.B. King Boulevard is named for the legendary blues guitarist. The low slung brick expanse of the building covers an entire city block, but its future hit some sour notes a few years ago when Gibson announced it would consolidate its manufacturing to a plant in Nashville.
Somera Road bought the building in 2017, and Fralin says there were five different business plans for its reuse before delivery giant Federal Express (which started in Memphis in 1973) was lured as a tenant for 150,000 square feet.
By 2020, FedEx will be leasing 200,000 square feet of the space for its logistics center headquarters, and Fralin says Somera and FedEx are in advanced negotiations to lease space in the office building next door.
From Memphis, Somera Road took the show to Music City, as the firm bought two of Gibson’s adjoining buildings in Nashville in 2017-18, converting them into mixed-use commercial and retail projects. One is now home to Pins Mechanical Company, a hipster bowling center combining strikes, songs and suds. The second acquisition will be converted to a large-scale, mixed use development that could approach 600,000 square feet of commercial and retail space.
The communal workspaces Somera Road favors are built in neighborhoods where other new development is spurring activities day and night. Somera Road may add amenities like a gym or rooftop deck, but the bigger lure is landing in markets that are heating up through buying undervalued properties.
“The first thing is cost basis,” Fralin says. “We’re sometimes buying properties at 20 percent of their replacement value; we’re coming in at very good levels.”
A whole new tax tune
Tennessee has been fruitful for the Somera Road model, but so are cities such as Cleveland, Detroit, and Louisville, Kentucky, with the advent of the opportunity zone program offering investors a method to defer, discount or abate capital gains taxes over periods of seven or 10 years.
“This is the next business phase,” Fralin says plainly of the opportunities coming in cities where Somera Road has already invested.
In the larger picture, Fralin handles all aspects of the deals–purchase and sales, office leases, financing agreements, third-party and vendor contracts. On the ground locally, he works with the officials and outside counsel and consultants to square away zoning and other local regulations that make or break deals.
“Once in the market, we get to know the local government, the interest holders and the other stakeholders. Other opportunities organically presented themselves from there.” says Fralin.
In Strongsville, Ohio, a horn’s blow from Cleveland, Somera Road bought a 125,000-square-foot vacant office building sitting on 20 acres. Somera Road and Fralin worked with local politicians and local community groups to rezone half of the site for ground-up retail development.
Fralin says the zoning change allowed the company to nearly 80 percent of the 75,000- square-foot center to tenants such as Homegoods, Panera Bread, Outback Steakhouse and City BBQ. In addition to the retail, the vacant office building was successfully sold by Somera Road to a local user.
His own tune
Real estate is such a passion for Fralin he is also a managing partner for Couzens Hall Advisors LLC in New York, where he offers consulting and legal services. A native of the Boston area, he credits his brother, a broker in northern California, with drawing his interest into the field.
Politics was also an early love for Fralin, who earned a Bachelor of the Arts from the University of Michigan in political science and government, and even served as a staffer of the later Sen. Ted Kennedy, D-Massachusetts, before entering law school at Boston College. He earned his Juris Doctor from BC in 2002 and began working in real estate law immediately thereafter.
Fifty properties later, the thrill of the chase has not waned for Fralin, and the change in strategies for acquisitions opens more avenues for Somera Road to grow. His first legal love has not changed, however.
“Complex real estate and structured financing is what I love most in my career, because it’s in this field that I cut my legal teeth,” Fralin says.
Originally shared on: https://www.vanguardlawmag.com/case-studies/michael-fralin-somera-road-inc/
FedEx Logistics is in advanced negotiations to lease part of The Clipper office building, which could also become home to FedEx Express and FedEx Services employees.FedEx nears lease of new Downtown tower
The new owner of SouthSide Works will get more time to develop the last three vacant parcels at the site, including two on the Monongahela riverfront, as part of a major overhaul that could include up to $25 million in investment.
Pittsburgh Urban Redevelopment Authority board members are expected to vote Thursday on whether to give New York-based Somera Road Inc. as much as four more years to develop the prime riverfront properties as the firm works to bring new life to the 34-acre retail, entertainment, residential and office complex.
Somera, a commercial real estate firm that targets distressed assets, took over SouthSide Works, site of a former steel mill, from Soffer Organization, the longtime owner, this summer.
In an interview Tuesday, Ian Ross, Somera founder and managing principal, said the goal is to bring the popular South Side destination back to life, particularly on retail side, which has fallen on hard times with empty storefronts dotting the streetscape.
Somera, he said, is planning to spend $20 million to $25 million to revitalize the property. As part of its deal with the URA, it also has agreed to invest at least $1 million to upgrade the town square and other public spaces. Mr. Ross said that spending likely will end up closer to $2 million.
He declined to say what plans Somera had for the riverfront parcels, one of which is next to the Hofbrauhaus restaurant while the other is located between the Hyatt House Hotel and an office building.
But Herky Pollock, a CBRE retail broker who has been serving as a consultant to Somera, said the firm is exploring the “highest and best use” for the riverfront land.
“There are many different options in play, and they’re currently evaluating which adds the most to the overall vitality of the project,” he said.
As for the vacant retail spaces within the complex, Mr. Pollock has said in the past that he envisions a mix that includes entertainment, health and wellness, restaurants, and perhaps even daily needs such as a grocery.
Under its agreement with the URA, Soffer had until next July to develop the three remaining parcels. It would have paid $450,000 an acre for the land.
As part of the new deal, the URA, which owns the land, plans to lease the tracts to Somera rather than sell it, with the price increasing the longer it takes to get a project rolling.
It is giving the firm up until July 1, 2022, to start developing the parcel next to Hofbrauhaus.
If Somera does so by July 20, 2021, it will pay $27,072 an acre each year under a 99-year ground lease. After that, the price per acre goes up to $55,000 until Nov. 1, 2021. And if Somera hasn’t started by then, the price jumps to $91,615 an acre.
Should the firm fail to start by July 1, 2022, the URA has the right to request proposals from other developers for that parcel as well as the one next to the hotel if no work has begun there.
If Somera does start development of the Hofbrauhaus parcel by July 2022, it will have until Oct. 12, 2023, to close on the land next to the Hyatt House Hotel. Annual lease rates for that parcel could vary from $27,072 to $78,209 an acre, depending on when work begins.
“We’re paying more if we take longer,” Mr. Ross said.
As with the other riverfront parcel, if the land next to the hotel is not developed by the deadline, the URA can issue a request for proposals to give others a crack at it.
The agreement also includes a provision to adjust the lease rate for the parcels by 5% every five years.
As for the third undeveloped tract, which is located at Sidney and South 28th streets, the URA will lease it to Somera long term at a nominal rate with a purchase option.
At least initially, Somera plans to activate and maintain a public-oriented space that could include a farmer’s market, a dog park or public art. URA officials said they structured the deal that way for that parcel because it is smaller and more difficult to develop.
Nathan Clark, the URA’s real estate director, said the agency decided on a ground lease rather than a straight sale for the riverfront parcels because it believes there is value in holding on to such assets. They also will provide a steady source of income for the agency.
“It’s not how we have traditionally done real estate. This seemed like a good opportunity to utilize the structure,” he said.
He and Robert Rubinstein, URA director of special projects, said the additional time given to Somera to develop the parcels is appropriate given the level of investment and commitments the firm has made to improve the complex, which has been a showcase for the city in the past.
“We think they have the balance sheet and the expertise to reinvigorate the retail portion,” Mr. Rubinstein said. “Retail is a tough thing. It’s just not here in Pittsburgh, it’s nationally. It’s continuously evolving and needs to be meticulously curated.”
Besides Hofbrauhaus, SouthSide Works is home to The Cheesecake Factory and other restaurants, a movie theater and apartments. It also is the location of the American Eagle headquarters and an Amazon tech hub.