Dealing With Distress in Commercial Real Estate

RECEIVERSHIP: A Broker’s Point-Of-View

Adam J. Tarantur, Senior Vice President

Distressed real estate is currently one of the most active sectors of the commercial real estate industry. 2011 saw an influx of properties go through the foreclosure process and ultimately into lenders’ hands. This trend will continue through 2012 and likely beyond. Although foreclosures are generally the product of a weak overall business environment, opportunities do exist for both buyers and tenants. An understanding of the process allows one to navigate through, and capitalize on, these opportunities.

Prior to foreclosure, a lender’s workout department handles what are considered to be problem loans. Factors that can contribute to a loan’s troubled status include loan maturation without repayment; missed mortgage payments; or a drastic drop in property value beyond specified limits within the loan documents. One of the workout group’s responsibilities is to interact with the borrower in hopes of formulating the most advantageous solution for both the borrower and the lender. When addressing problem loans, it is prudent to be candid, courteous and open-minded. The less animosity and unnecessary pushback a lender receives from a borrower, the more likely they are to work towards the least painful outcome.

It should also be noted that sometimes a lender will not engage in discussions with the defaulting borrower, and will begin foreclosure proceedings immediately upon default and lapse of a cure period, if one exists. It is also during this period that a lender may try selling the mortgage note. This strategy aims to shift risk to the a buyer, usually by offering to sell the note at a discount. This is not always the case, for instance, if the value of the underlying real estate exceeds the loan balance.

Properties that have been “taken back” by the lender are commonly referred to as Real Estate Owned (REO) or Other Real Estate Owned (OREO). The shift from a lender’s workout department to its REO department isn’t always the smoothest of transitions. Depending on the size of the institution, the individuals within the respective departments may not even know one another. Typically there is a learning curve as the new asset manager wraps their hands around the asset, which may produce delays. Add a new property manager and leasing/sales agent transition, and there will likely be slower responses. Be patient, yet persistent, as the new owner (the lender) gets comfortable with the asset.

Many problem loans are acquired through the purchase of either a failed banking institution or a pool of loans. In the former case, the lender frequently has a loss sharing arrangement on the assets with the United States FDIC. Essentially, the government becomes their “partner” on the property, as an inducement to assume the risk associated with the failed bank’s loans. Doing so creates another possible hurdle, as the value lenders need to garner for individual properties is largely dictated by the value established in an appraisal. Appraisals can sometimes create unrealistic pricing expectations and hamper a lender’s mental, or real, ability to sell an asset, given current market conditions.

Given the large volume of property currently being taken back by lenders and their desire to stay profitable, many asset managers have a huge number of properties—of all types and in myriad locations—under their control. This too can cause delays in response times, decision-making, and the transaction timeline.

A clear understanding of the process and potential hurdles, as well as an agent’s involvement in document negotiation, alongside a capable real estate attorney, is the best way to ensure you are taking advantage of a distressed opportunity and not the one being taken advantage of.