Since early last year, commercial real estate investors havebeen eagerly awaiting the deluge of distressed properties to hitthe market. They're still waiting. And chances are, they will befor some time, since property holders are still wary of sellingassets into a bad market. So what's an investor to do? Considerfunneling your capital into distressed debt. There's no questionthe opportunities are out there, as the pool of non-performingloans grows ever larger. Though other property sectors may be inmore trouble than apartments, it doesn't mean investors looking tomake multifamily plays won't have plenty to choose from. In itsJanuary report, Trepp reported that the multifamily CMBSdelinquency rate rose nearly half a percent to 9.71% (and that'snot even counting Tishman Speyer's Stuyvesant Town/Peter CooperVillage deal). And Real Capital Analytics reported that by year-end2009, there was $22.7 billion in troubled apartment assets in themarket. Even exempting those deals that will be worked out orrestructured, there will be plenty left over for anyone interestedin loan-to-own transactions.

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Though not a newdevelopment by any means, investing in distressed debt deals as away to obtain property is a tactic that's increasingly gainingfavor among private equity players. As illustrated in the latestissue of Distressed Assets Investor, there are severalways to execute this strategy, often known as loan-to-own. Thepurest form is to come into a distressed scenario and either buythe defaulted loan at a discount from the lender or provide thecapital to pay it off, effectively becoming the new lender. If theborrower somehow continues to pay on time, the investor gets paidinterest fees. If the borrower defaults, the investor gains controlof the asset-at a cheaper cost than if it purchased the propertyoutright. The investor can also come in and provide theborrower-which is effectively backed into a corner thanks to thelack of financing in the market-with capital to pay down the debton the asset, thereby purchasing a stake in the property. Often thenew capital comes with caveats. If it's in the form of a loan, itgenerally has high interest rates, often in the mid-teens. (Ifthe borrower couldn't pay its original loan, what would make anyonethink it could pay a more aggressive one? But I guess that's thepoint, huh?) The borrower defaults and the investor gets theasset. If the investor provides an equity infusion that gives it apartner role in the asset, it can structure the operating agreementin its favor and have a say in how the property is run. If theborrower is able to bring the property to a good level ofperformance, the investor can either sell its stake to the borroweror a third party for a profit. If the property fails or theborrower cannot hold up its end of the bargain, the investor getscontrol of the asset. The deed-in-lieu-of-foreclosure option alsoallows the investor to avoid the legal costs of a foreclosureprocess. Of course, there are other variations to the strategy andcertain nuances-such as the complications investors in securitizedloans may face-that investors should consider, but for brevity'ssake, I'm not going to get into them here.

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The term"loan-to-own" is generally considered a dirty word in commercialreal estate circles, since it insinuates ulterior motives on thepart of the investor. Some of these investors are consideredvulture funds, and there have been accusations that loan-to-ownplayers execute these deals with the sole intention of theborrowers going into default, or that the equity partner may coercethe borrower into exiting the deal by making it difficult orunprofitable. That's why those that so use this strategy aregenerally known as hard-money, asset-based or mezzanine/bridgelenders. A quick Google search brings up hundreds of firms thatbill themselves as such-Kennedy Funding, Arbor Commercial Mortgage,Metro Funding Corp., Aries Capital, Greystone Commercial Finance,AREA Property Partners (formerly Apollo Real Estate Advisors) andCohen Financial, among others. Yet there are some companies thatare unabashedly embracing the loan-to-own strategy. Last month,Fifield Realty Partners LLC announced a new $200-million apartmentacquisition fund focused on buying core-plus and value-addproperties, short-sale deals and loan-to-own acquisitions. The firmand its institutional partners hope to buy as much as $600 millionin properties nationally, amounting to more than 5,000 units.Private equity firm AION Partners last year bought the loans on aneight-property portfolio of primarily multifamily assets in sixstates, valued at more than $110 million. So far, it has foreclosedor taken a deed-in-lieu on five properties, and expects to takeover the rest of the assets this year. In an interview with DAI,AION principal Michael Betancourt says the firm looked for loanswith shorter maturities. "As a lender, you have control, so we takeproactive steps to put pressure on the borrower," he admitted. Theproperties gained in the deal are the first in what the firm hopesto grow into a larger portfolio; it is eyeing other distresseddeals it could take advantage of. And there will be even moreopportunities for investors to take advantage of distressed debt asthe FDIC sells off the assets of banks it has seized. So, do youthink loan-to-own is an effective strategy for multifamilyinvestors looking for a good deal? Or, would the presence of theGSEs, along with the positive view many traditional lenders have ofapartments, throw a wrench into these opportunistic players'plans?

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