New Concerns for Lenders Create Strong Need for Strategy

(Visit the Distressed Assets page on GlobeSt.com.)

The most important element when working with a distressed property is to develop a strong strategy. Without mentally working through each option ahead of time to determine which outcome is preferred, it is impossible to manage the complexities that arise with distressed assets.

An asset manager can assist in developing these strategies in order to enhance the financial performance of an asset. It is helpful if these strategic recommendations come from two perspectives: financial and physical. For example, Voit’s integrated brokerage and asset services provide both of these perspectives to owners of distressed properties. This enables a team to take a distressed property from start to finish on behalf of real estate owners.

As distressed situations become more complicated, lenders are facing new challenges. One emerging difficulty is the way in which some borrowers are responding once a loan goes into default.

In some circumstances, borrowers are manipulating the system and simply withholding money from lenders. Some borrowers in default are still collecting rents from tenants, pocketing the money, and awaiting the next move by the lender.

These borrowers continue to ward off foreclosure by promising the lender that a buyer is on the sidelines, or a lease is in the works. In the meantime, the property is often negatively impacted as it becomes ill maintained.

These borrowers feel entitled to these funds, even though they are essentially robbing the banks. To counteract these unfortunate circumstances, lenders are forced to put properties into receivership or foreclose quickly, which can then alleviate some of the pressure by redirecting whatever cash flow is available from the asset back to the lender.

Another issue is that some borrowers are accepting less-than-desirable tenants, which endangers the value of the property. This is especially evident in retail properties, where questionable tenants have been allowed to lease space alongside more traditional retail tenants.

For example, a class B retail center that Voit is assessing in Arizona has a number of strong tenants, including Subway, Chipotle, a gym and a pizzeria. In addition to these businesses, the borrower has now leased space to a tattoo parlor, an academy to instruct medical marijuana dispensaries, and a smoke shop, among others.

These are not the types of retailers that are typically seen in class B centers, and it is evident that these tenants were put in place due to an immediate need for cash flow. The real difficulty lies when it is time for disposition, as it becomes difficult to value the property with these questionable tenants in long-term leases.

The question of value on distressed property is always complex, as the due diligence that is completed for traditional properties is just not available on REO properties. Typically, buyers are seeking historical financial information, allowing them to better determine the true value of an asset. This history provides an accurate snapshot of what has occurred, and is helpful in predicting future cash flow.

In the case of a distressed property, the asset must be sold based solely on projections of value. These projections are typically derived from strategies developed to stabilize an asset, which may include a lease-up scenario, repositioning plan, or redevelopment opportunities. The result is a value that is more difficult to prove than a traditional property, for which historical data is available.

For example, if a property is 60% occupied, a broker may value the building by focusing on the potential lease-up. If the building is valued at $1 million today, the broker may suggest that the actual worth is $1.2 million, based on the potential to lease the remaining space. The difficultly arises when a potential buyer does not agree with the projected value.

The key to navigating these varied perceptions of value and helping a lender to determine the best solution for an asset is to provide a variety of strategic options.

For example, Voit was recently assigned to provide asset management for a lender who had foreclosed on a property consisting of numerous buildings spread out across a number of different locations.

The complexity of the project could be overwhelming, so we simplified the process by developing four scenarios—each with a different value structure. In this case, these strategies included:

1. Dispose of the property as a whole, reducing time spent seeking separate buyers.

2. Lease the buildings and sell them as stabilized investments, resulting in the highest potential financial return.

3. Divide the buildings into pools based upon size and geography, then sell each pool of assets separately. This lessens the overall time in marketing the project and potentially increases total returns.

4. Sell each building individually, decreasing the monetary loss the lender would take on the property.

On this property, the lender selected option one, and the Voit team oversaw the disposition of the entire property in bulk. While the lender took a greater loss than it might have experienced by selling the condos individually or leasing them first, the transaction was more rapid, which best fit the lender’s distressed asset needs.

Moving forward, complicated situations surrounding distressed properties will continue to emerge, but with strong strategy and ongoing demand from buyers, lenders will continue to find solutions.

Amr Ceran is asset manager in the Phoenix office of Voit Real Estate Services. He may be contacted at aceran@voitco.com. The views expressed here are the author’s own.