According to several analyses of commercial real estate there is a group of properties valued in total around $2 Trillion whose loans are maturing in the next 2 to 3 years. Many of these properties are “distressed”.
While this looming debt may pose a threat to the recovering economy, it also represents opportunities for much of the commercial real estate industry – brokers, lenders, equity investors and due diligence professionals will be busy as bees working through the many distressed properties.
The lenders/owners will have several options to resolve the issue. Three possible approaches for lenders and owners are to: 1) foreclose on the loans and sell the collateral, 2) sell the loans at what the market will accept or 3) sell the asset at a loss. These options involve a transfer of property rights.
Whether or not an asset or debt sale is considered, the physical and environmental status of the property should be part of the transaction evaluation.
Physical Condition Assessments
Because the property is “underwater” it is likely that reduced income will mean physical maintenance has been neglected. This can be a leaking roof, poorly maintained mechanical and electrical systems and building interiors, exteriors and site conditions. In order to understand these issues the owner/lender should hire a qualified engineering firm to produce a Property Condition Report. This report will discuss the findings of a site inspection. It will also estimate the deferred maintenance/immediate repairs that are required because of imminent damage to the property as well a projection of annual costs to maintain the physical condition of the property. The current status of building codes compliance will be researched and included in the Property Condition Report.
Even though often a Phase 1 Environmental Site Assessment may have been completed at the time of the loan origination or purchase, conditions on the property (or surrounding properties) could have changed since that time. In particular, properties that store or use hazardous materials on site that did not have any significant issues in the past could have very costly issues at the time of property loan transfer or sale. A gas station may have had a release causing soil or groundwater contamination. Or, at a multi-tenant industrial facility, the other side of the deal will want to know how many hazardous materials are on-site and determine how to properly dispose of them. In the hundreds of Phase 1 ESAs Partner has done on behalf of owners and lenders, it is not uncommon for the owners to have been delinquent and the tenant spaces to be in bad housekeeping condition.
Other conditions such as regulatory compliance issues, operating permits, underground storage tanks that need to be removed, on-going remediation, wetlands on the property, asbestos and mold are all conditions that could exist at a property. A thorough Phase 1 ESA, a compliance review or perhaps even Phase 2 soil or groundwater testing, can help identify and assess whether any of these factors are present.