It didn’t take long after the COVID-19 economic slowdown began before commercial real estate pros began anticipating the distressed cycle that would inevitably follow.
The pain has varied by sector, with the hospitality and retail sectors faring the worst. It is just a matter of time—after forbearance periods and loans have go into default—before deals should creep to the market.
An immense war chest has already been amassed aimed at taking advantage of these distressed opportunities. Many still remember how things played out after the Great Recession, and the vast fortunes that were made by cleaning up on troubled assets.
But will this cycle be a repeat of that period?
NREI sat down with Carol Faber, co-chair of the distressed property practice at Akerman, to explore how the COVID-19 distressed real estate cycle might play out and the similarities and differences between now and the last distressed cycle.
The following interview has been edited for style, length and clarity.
NREI: What are some tips for owners who may have trouble paying their loans right now?
Carol Faber: It is still in the early stages in that even though this started a couple of months ago, people are still trying to get their bearings. They are figuring out how long this will go and how deep it will be. Who will survive? Who will not?... So that is why we’ve seen a lot of short-term “wait and see,” such as forbearances for 30, 60, 90 days. There are some modifications. But for the most part nothing really major yet.
Most borrowers that think they will have a problem or that already have a problem have likely reached out to their lenders already. A lot of borrowers were able to make their April loan payment because they were making at least some money in March. Depending on the asset class, some of that has fallen off a cliff at this point.
The most important tip is for borrowers to be frank and straightforward with their lenders. Have a very specific ask, which isn’t pie in the sky. Lenders don’t want to hear you come and ask for a deferral of interest payments for the next year, for example. That is not going to happen. Come in with something realistic: a deferral or reduction in payments or relief from some of the financial covenants for a specific period of time. Ask for the release of some or all of any money in reserves, to be used for a specified purpose.
Explain why you need the relief. Explain what your specific issues are right now and in the foreseeable future. That might seem crazy…. But lenders have figured out that not every borrower needs relief and that borrowers don’t all need the same relief.
Lenders are more likely to work with and give concessions to borrows who look like they will still be standing at the end of the day. So, borrowers really need to put their best foot forward.
Different types of lenders (CMBS, banks, life insurance companies) are all a little varied in their approaches. But generally speaking, right now they are working with borrowers to the extent that they can. Many of their borrowers are having issues, so they have to deal with it. They also don’t necessarily want to, or can’t, proceed with foreclosures right now. Especially if they are not “loan to own” lenders they are going to work with borrowers as much as they can.
NREI: Talk about the experience of the last cycle. From what I remember, the opportunities for distressed properties and debt didn’t emerge immediately. They took some time to get to the market. But then we had a multi-year period where investors in distressed debt and real estate had a lot of opportunities that ended up delivering returns. Do you expect a similar kind of process?
Carol Faber: The biggest differences are that going in this time the economy was doing well and real estate was doing well. Except for companies which were having problems before this hit, overall things were good.
In the Great Recession there were economic problems across the board. This is another reason why lenders are willing to work with borrowers today. This wasn’t caused because there were pre-existing systemic economic issues.
The other difference is this happened suddenly and unexpectedly. The last time, the initial events were sudden. But once it started, it rolled out to various sectors over time. It didn’t go from zero to 60 in matter of days and weeks.
All of which will have an impact on how we get back out of this situation. It will depend on how fast the economy will get up to speed. Lately people seem to be feeling more optimistic, but this is a long game, and it remains to be seen how this will play out. One of the biggest factors is that nobody knows yet how to value these properties. That is going to have a big impact going forward.
And of course there is a danger in making these big global statements. On the whole, industrial and even multifamily are still strong. So, you can do valuations on those. But those are not in the same distressed situation that retail and hospitality are; and even in those sectors, you have to drill down, as some properties and markets will not be as impacted as others (for example, resort/conference properties vs. local getaways). And office is still somewhat of an unknown.
As a result, there is a bit of a disconnect across the system.
Sellers think their properties are worth more than what buyers are willing to pay right now. That goes all the way up the chain. For lenders that are trying to offload debt, there is a disconnect in how to value that. And for an entire portfolio, it will depend on the asset mix, and how impacted those assets are.
But all of this will become clearer, and as it does, there will most definitely be more and more opportunities available for investors of distressed properties and distressed loans.
NREI: What kinds of investors and lenders do you think will be best positioned to capitalize on distressed opportunities?
Carol Faber: Without trying to sound too flippant, the ones with money. The investors that have money to make deals and to hold properties for the right moment. A lot of money is being raised and out there for this. They are going to be in the best position. And obviously they need to be smart. They need to know the markets. There is money to be made in all of them. But this is not a situation for the inexperienced to just jump into. You really need to know what you are doing in all respects: as to the specific real estate and asset class, the financials, and the legal implications ranging from understanding the loan documents and the ability to enforce them including potential bankruptcy issues, to due diligence on the property for legal compliance, liens, entitlements, hazardous materials, to tax implications. It is important to understand the interplay and to be getting good expert advice.
NREI: Are banks in a position to keep REO on their balance sheets for a period of time, or will they try to move quickly to dispose of those assets?
Carol Faber: The Great Recession wasn’t that long ago. Most of the people around today went through that, and learned from it. The Great Recession was so shocking—the extent of it, the depth of it. There were so many people then that didn’t know how to deal with it.
Now, this is also an unprecedented event. But most people remember having gone through the last cycle, and most lenders had systems set up to deal with it in a way they did not last time. Most lenders understood right away they had to react. They really took this very seriously, and jumped in.
And of course, this is also a very regulated industry. So there will be limits to how many defaulted loans they can keep on their books.
Last time, the whole “extend and pretend” strategy was less of a strategy than it was the inability to deal with the amount of distressed and defaulted loans. But it ended up serving some lenders very well. Some of those loans, had they resolved them early, would have had a worse result. Some of the loans that got kicked down the road ended up recovering, the property values and revenue came back, and everyone ended up being OK, or at least better off than they would have had they acted quickly. That may be playing into why lenders are taking a more measured approach today.
COVID is impacting specific property types more than others. So this may not be an economic disaster across the board. For lenders, all of their loans will not be bad.
Hotels and retail, everyone is talking about. It remains to be seen what will happen with offices.
Clearly there will be some challenges there. Office space is going to look very different. A lot of people are working from home, but more space for social distancing will be needed for those who do go back to an office. And some people may work in shifts. On the other hand, people are social and like to interact with others in person, and companies like the interaction and creativity that offices foster.
Honestly, right now we are in the middle of it and it seems so overwhelming. But we will come out of it. There will be a vaccine or immunity and life will go on. We will want to go back to work and to play, although it will look and feel differently than it did before. Situations always change and evolve. This whole pandemic mentality can’t stay as it is. You can’t remain in a state of emergency forever.
NREI: Any last thoughts?
This pandemic has had a major impact on the US and the world. The number of deaths is astounding, and the personal toll that takes is incalculable. But I think we are getting to the point where there is a general sense that everyone wants to come out and restart the economy. Nobody is against that…. People want to be able to safely go out, be social and spend money. The more people want to and are able to do these things, the faster we can rebound. The more that governmental programs are able to get people to feel comfortable spending money, the faster we are going to get out of this. That is a very critical part of the recovery: how much these programs are able to get money into the system at every level. The more that liquidity is available, the quicker the recovery. If people are able to do that in a safe and responsible way, so that there isn’t a big second wave, that is really going to help.
Overall my feeling is more optimistic than not for all of the reasons we touched on. The underlying fundamentals are strong. This will pass. People will get out. All of that will help us move past this. That said, there will be a lot of pain. There will be a lot of distress. There will be winners and losers. And we will be dealing with that for at least the next couple of years. But that is the cyclical nature of commercial real estate.