Opportunity in the Commercial Real Estate Market

Most people in the real estate industry believed that the crash of the early 1990′s would be a once in a lifetime event. However, it appears that the distress of the current economic environment will far exceed that of the early 90′s. Counter-cyclical investors took advantage of depressed values and made fortunes. Similarly, the period between now and 2013 will represent the greatest opportunity to cash in on distressed properties.

So what exactly will the opportunities be to invest in distressed property?

Distressed Debt Acquisitions
Due to the sharp decline in property values, many of the loans made to finance certain real estate acquisitions exceed the value of the underlying property. Additionally, as many loans approach maturity, investors are unable to refinance in an environment filled with de-leveraging. Therefore, investors with patient capital will be able to acquire first mortgages or other debt instruments at a deep discount.This could result in a near term high IRR realization or acquisition of the property via foreclosure.

*Update: Many banks have taken an “extend and pretend” approach to maturing loans as the FDIC wants to allow banks to rollover commercial loans that are at maturity, and not require they be marked to market. If the FDIC forces loans to be marked to market at maturity, we’ll realize a flood of distressed deals coming to the market. Although there has been a lot of capital raised to purchase distressed assets, it wouldn’t nearly cover the amount of distress. This could cause an even greater crash and is something the government doesn’t want to deal with. On the other hand, if the FDIC allows loans to rollover, banks have time to sure up there balance sheets and eventually realize the loss when they can handle it. This will lead to waves of distress, which can be absorbed by the market, but will delay the pace of recovery. It’s a question about how you want to recognize the losses, you can recognize it in workers unemployed, underutilized resources, or you can bite the bullet, someone has to pay the check, and the economy moves on.

Recapitalizations
Companies with expertise may be able to step in during a restructuring and take control of the day to day operations of a distressed property. The borrower may be left with a tax deferral or some sort of income stream. The firm will provide equity capital to the borrower to allow them to retain some involvement in the transaction.

Failed Developments
There will be many projects where the developer goes into default prior to completing the project. In such a scenario, most construction lenders are ill-equipped to finish the jobs themselves. There will be opportunities for companies to buy into the developments at a significantly reduced price, complete the job, and potentially give the lender some sort of back-end participation. Such an effort would require vast development experience.

Institutional Divestitures
Institutional real estate investors are many times forced to exit the real estate market at inopportune times in a cycle. Many of these investors are being forced to sell healthy real estate assets in order to generate liquidity, for a variety of reasons. These opportunities can be viewed as another form a distress. If a company has the ability to act quickly, they will be able to take advantage of these opportunities.

Although there are very little distressed deals at the time, over the next couple of years opportunity will be unprecedented. It will take strong relationships, experience, and capital to cash in on these deals. Where do you see the most opportunity in this market?

Similar Posts:

• Wildwood Crest, NJ – An Example for Potential Real Estate Opportunities in Beach Towns
• S&L Redux: How Long Should we Expect to See Distressed Assets?
• Sam Chandan on the State on the Commercial Real Estate Market

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