Distressed Deals and Note Sales on the Rise
We are in a period in which cap rates are higher, returns are tightening, and property values still remain fairly high. Investing in distressed property also incurs additional risk for the investor since they are the party executing the foreclosure rather than the original lender. Foreclosure and bankruptcy processes can take years sometimes, and as such, require appropriate discounting. Finally, the opportunities vary widely by market sector, property age/condition, and location. Banks are in the business of making money on financial instruments, not managing real estate assets. Lenders are reluctant to take back a property through the expensive and time-consuming foreclosure process, nor do they want to own and operate complex and management-intensive assets. You can imagine the headaches for a lender that has office buildings on its balance sheet that need to be repositioned, repurposed, or re-tenanted. Not only does it represent significant capital expense and risk, it’s siphoning away time better spent on their core mission.
As a result, we are seeing a trend towards banks selling notes instead of taking properties through foreclosure. At the same time, that trend is being noticed by private equity firms seeking to capitalize on the long-term prospects of commercial real estate: According to Ernst & Young, about $1.2 trillion is available for investment in commercial real estate, up from $900 billion in 2021.
That isn’t to say that smaller investors can’t get in on the action of loan acquisitions—but this is not run-of-the-mill investing as you find in the acquisition of typical commercial assets. While institutional lenders may not want the expense, time, and trouble to foreclose on non-performing loans, an opportunistic note buyer typically will have to step into the lender’s shoes to foreclose and acquire the property, or otherwise collect on the loan instrument. The R.O.I. Properties team is currently working with several buyers of notes, helping them to formulate strategies to value, manage, sell and/or turn the notes/properties around. Executed properly, such deals allow an investor to own a property at a discount and reap the benefits of potential increases in rental rates, other revenue/redevelopment opportunities, and valuations, as the economy improves.
GlobeSt.com recently estimated there will be 3,600 distressed deals during the next two years from which to choose. Although experienced real estate investors may try to discover potential distressed investment assets on their own, it is an extremely competitive market and the process is often best executed with expert help and an extra dose of caution:
- We are in a period in which cap rates are higher, returns are tightening, and property values still remain fairly high.
- Investing in distressed property also incurs additional risk for the investor since they are the party executing the foreclosure rather than the original lender. Foreclosure and bankruptcy processes can take years sometimes, and as such, require appropriate discounting.
- Finally, the opportunities vary widely by market sector, property age/condition, and location.
Suffice it to say: In addition to plenty of dry powder, the phrase caveat emptor needs to be part of any investor’s distressed property strategy
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