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Buying distressed properties

Posted: February 26, 2013 2:00 a.m.
Updated: February 26, 2013 2:00 a.m.

Darcey Oldhafer

 

Real estate development during the Great Recession has proven to be a very challenging endeavor. Even seasoned professionals have found themselves struggling to service debt on projects that are producing monthly net negative cash flows.

Loan modifications, while rarely discussed during times of prosperity, have become common vocabulary in the industry. In spite of these challenges, the economic downturn has produced some unique opportunities for developers who still have resources available.

If a property owner is unsuccessful in negotiating a loan modification, banks often proceed to foreclosures or note sales. In an effort to clean up their balance sheets, banks have grown more amiable to selling Notes than in days past.

When a bank sells a Note, they are selling the loan to another entity who then becomes the lender. The Note is typically secured by a Deed of Trust on the property and may include any personal guarantees that were signed. These Notes have been sold for pennies on the dollar as compared to the outstanding debt, penalties and fees.
Although buying distressed assets can be desirable, there are some inherent risks. Notes are most often sold “as-is.” This means that any title encumbrances or liabilities (even lender liabilities) become the responsibility of the Note purchaser.

Thorough due diligence and underwriting are the keys to a successful transaction. For those firms with the appropriate professional skills and capital base, however, these strategies can be extremely profitable.

Note purchases and the purchase of bank owned property can be a trying process. Lenders often require incentives to approve the reduced pricing. Often these incentives include quick closing which makes it difficult for buyers to secure financing. Having access to immediate funds is a crucial negotiating component.

According to Dale Donohoe, President of Intertex Companies, now is the time to buy.

“Most of the opportunities that have presented themselves have been attractive in terms of investment potential. These deals aren’t easy, but they are feasible,” Donohoe said. “This type of market positioning makes it possible for commercial landlords to compete in today’s tumultuous environment.”

The lesson to be learned from the misfortune of many commercial landlords is to keep leverage low. A property needs to be able to service its debt when it is well below 100 percent leased and well below 100 percent of proforma income.

Although percentage-occupancy has historically been the measure of appropriate debt service, recent history has taught us that the percentage of rent payment should also be considered.

It used to be the case that tenants either paid rent or they didn’t. If they paid less than full rent, they were evicted and replaced. With very limited replacement tenant opportunities, however, landlords have worked with tenants to allow partial payments, which make full debt service nearly impossible.

In some situations it is possible and preferable to form joint ventures with property owners who don’t have the capital required to restructure their loan. This allows investors to participate in the potential upside of the project while utilizing the market and asset knowledge of the current owner.

Although there is frequently disparity between the owner and investor’s asset valuations, there is motivation on both sides to reach an agreement. The structuring of the joint venture agreement is critical to ensure that all parties will attain their investment goals.

Even with all of the investment opportunities that are available, the pool of potential buyers is limited due to the conservative lending requirements and required resources.

Working with distressed properties is an opportunity to turn lemons into lemonade, Donohoe said. Distressed asset opportunities have been the silver lining in this market. And although a positive turn in the market has begun, times are still tough.

Darcey Oldhafer is the Development Manager for Intertex Companies. Ms. Oldhafer’s column reflects her own views and not necessarily those of The Signal. Her guest column was selected to describe how many developers and builders worked creatively to survive the Great Recession. Intertex is located at 26074 Avenue Hall in Valencia and can be reached at 661-702-2222.

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