Distressed real estate deals may look like golden opportunities, but their complexities often trip up even experienced investors. Todd Laurie, partner at Armanino, tells GlobeSt.com that too many buyers rely on financial data and surface-level explanations of distress without understanding the deeper forces driving a property's decline.
He said many crucial problems aren't visible during underwriting and emerge only through detailed operational and local analysis. Shifts in traffic patterns, zoning changes, deferred maintenance due to limited capital, and long-term breakdowns in property operations can slowly erode performance, Laurie said.
Institutional investors and programmatic investment sponsors who have reviewed hundreds of deals are typically more familiar with these hidden risks, he explained. In contrast, non-institutional investors, individual owners or newer sponsors often lack experience navigating through multiple economic cycles — leaving them vulnerable to costly mistakes when pursuing distressed CRE opportunities.
Laurie noted that returns for properties successfully revitalized are highly attractive, but the downside risk can be severe if investors misread the situation.
"Think of a new medical doctor going through residency; you must see the deals or have an experienced mentor to know of the possible issues that lurk beneath the surface of a deal," he described.
The key, Laurie said, is distinguishing between "fixable" and "structural" distress.
"The solution to a structural issue lies outside the power of most experienced real estate investors to fix," he said. For example, investors are unlikely to influence traffic volumes, remove a raised median that blocks access, or reverse broad consumer trends such as declining alcohol consumption.
"Fixable issues are items that an owner/investor can reasonably plan and budget for," Laurie said.
A shopping center hampered by vacancy due to prior ownership's lack of improvement funding, for instance, could be repositioned through tenant improvement dollars to attract new leases. Likewise, a property burdened by deferred maintenance can often be stabilized through planned repairs and upgrades, he said.
"In some instances, a structural issue may be fixable by one investor but not another," Laurie noted. That distinction hinges on expertise and experience.
"If an investor has no experience handling environmental remediation projects, they should most likely pass on this type of deal," he added. "Another investor who is experienced in remediation projects and can purchase an asset on a basis that allows them to accomplish this while generating attractive returns may see this type of distress as an attractive opportunity."
Laurie emphasized that thorough due diligence is essential in any distressed deal. "It must always be thorough; there's no question," he said.
While diligence may be routine or even rushed for stabilized properties, he cautioned that distressed investments require a far deeper review to identify and plan for every obstacle to stabilization.
"Frequently, individual real estate investors rely solely on the input of the seller, broker, and perhaps their banker for vetting deals," according to Laurie. "In stabilized deals, this may be sufficient."
When it comes to distressed assets, however, "this is rarely enough," he said.
"It's imperative that distressed real estate investors engage with experts who can guide them through a comprehensive due diligence process. Or consider working only with experienced distressed real estate investment managers with a solid track record."
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