Are Investors Prepared to Buy Distressed Properties?

It's time to rethink those bid terms.

Investors in 2010 expect to find commercial real estate opportunities priced at a fraction of past values. Yet despite investor demand and a flood of distressed assets, deal volume is low.

The scarcity of trades is partially due to the complexity of distressed deals. Real estate underwriting methods and terms that bidders offered in the mid-2000s offer little assistance to investors attempting to purchase a whole loan or a lender's real estate owned (REO) property.

Distressed opportunities require expertise beyond a grasp of real estate fundamentals. The investor may need to consider non-traditional transaction structures, financial instruments, creditor rights and the potential cost of foreclosure and other proceedings.

Even with multidisciplinary expertise, how can investors decide which deals to pursue? Let's consider the most accessible and readily understood opportunities: REO and whole loan sales.

REO grande

Of today's lender-controlled offerings, REO deals are the most straightforward for a real estate investor because they involve a direct property sale. In practice, investors' REO purchase offers often receive a lukewarm response.

Banks have been inundated with bids for their REOs. More importantly, lenders say buyers frequently attempt to renegotiate price midway through a deal, or are unable to obtain equity or financing.

A successful REO buyer demonstrates a commitment and ability to close rapidly, and investors are learning that offering concrete terms can help to push their bid to the top of the seller's list.

Recently, a lender engaged Marcus & Millichap to market a multi-family property in Arizona and received 54 written offers. The seller selected a buyer that had already completed its due diligence, had provided a substantial deposit and was able to close within a week.

The takeaway from this and similar transactions: Lenders prefer certainty of closing, and certainty increases with short due diligence and all-cash terms.

Investors take note

Investors are increasingly focused on whole loan purchases as a path to obtain commercial real estate. As the lender on a defaulted loan, an investor may be able to foreclose and take title. Investors must realize that the purchase of a whole loan doesn't include the collateral's title, guaranty title or rent collection.

A whole loan purchase requires specific underwriting methods and transaction considerations. Bidders are not allowed to contact borrowers or tenants, for example. Investors must consider state foreclosure laws, bankruptcy risks, rights of other lien holders and abilities to assert rights to collect rents.

Is the investor prepared to hold the note if the borrower files for bankruptcy prior to a foreclosure sale date? If the borrower cures and brings a loan current, is the investor prepared to collect payments and forego ambitions of owning the collateral? Should value be afforded to corporate or personal guarantees in the purchase of the loan?

Most experienced lenders will rule out loan purchase offers with due-diligence periods suited to title transactions, which may allow 30 days of due diligence and another 20 days to close.

Lengthy terms highlight the investor's inexperience with loan purchases, which typically limit due diligence to document and title review.

The buyer of a loan portfolio on office property collateral recently distanced itself from other bidders by placing the entire purchase amount in escrow with the bid submittal, demonstrating their ability to close. Again, due diligence was less than one week.

As investors conform to lender standards on their bids and focus on deals with the highest probability of closing, they will dramatically increase their acquisition success in 2010 and beyond.

Jacob Steele serves as an associate director of Marcus & Millichap's Special Assets Group. Contact him at [email protected] or (303) 328-2000.

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