In the current real estate environment, foreclosures are not widespread but they are occurring. Delinquency rates at U.S. banks were at an eight-year high in the second quarter of 2002 due in part to defaults on commercial and industrial loans, reports the Federal Reserve.
When foreclosure occurs, a court proceeding often determines who will assume temporary management of the property. To ensure that property values are maintained during the foreclosure, officers of the court must hire property services teams that understand state laws and real estate processes well enough to help the property emerge from foreclosure in better shape than it arrived.
Operating an office building effectively during foreclosure is one of the most challenging jobs in real estate. The foreclosure process typically requires an interim property services team to turn around a property in just 120 days, a period that is commonly used in bankruptcy court. In this tight timeframe, the foreclosure team — including property management, leasing and construction management professionals — needs to quickly size up the situation at the property, establish a turnaround plan and create exit strategy recommendations.
In the first 30 days that the property services team is on site, three issues dominate the agenda: existing leases, security deposits and vendor relations. In the following 90 days, the strategic focus shifts to preparing the property for sale. Property service providers may make serious errors if they do not fully understand the impact of foreclosure on each phase of the turnaround.
First Thirty Days
In the early stages, the transition team needs to keep in mind the repercussions of actions taken early in the foreclosure takeover, including rejecting or accepting any existing tenant leases. As soon as a rent check is accepted from a tenant, the ability to disavow or renegotiate that lease disappears.
The same goes for security deposits. In accepting a lease by cashing a rent check, the new owner can be automatically responsible for refunding a security deposit. However, if the previous owner depleted the security deposit funds, new ownership may be responsible for paying out those deposits, and therefore, may want to renegotiate the lease.
Finally, new service providers also must decide whether to accept vendor service contracts before they make payments. It is important to note that the transition team is not obligated to pay vendors owed money by the previous owner.
Preparing the Property for Sale
After the first 30 days, the strategic focus shifts toward a plan to prepare the property for sale, requiring participation by skilled construction management and investment services professionals.
The 90-day repositioning process starts with development of a business plan that addresses a range of staffing, administrative and operational functions, from auditing on-site inventory to assessing hardware and software needs. Accomplishing this range of tasks in a short timeframe requires an experienced property services firm with resources to devote to the process.
A major focus of the repositioning is the analysis of the cost and potential value created through capital improvements. A property management and construction management team must identify the necessary work and accurately estimate the cost in order to advise final decision-makers on the best strategy.
If major repairs are needed, the best course of action may be to let the eventual buyer put money into renovating the property. For instance, upgrades such as new carpeting or windows may not be necessary in turning around a foreclosure, although they might be completed in a typical building repositioning.
On the other hand, if repairs to the roof, parking garage or other infrastructure are needed, it is often better for the property services team to handle the competitive bidding and have the repairs done prior to sale. Otherwise, potential buyers will factor in the risk of uncertainty in their purchase offers, resulting in a discounted sale price. A property services firm with an independent construction management department can obtain the best pricing and make repairs with the least amount of disruption to tenants.
At the end of the 120-day transition period, a well-executed property management process will have produced a forward-looking solution that includes an assessment of the property's current value, necessary capital improvements, strong relationships with tenants and vendors, and an exit strategy.
If the transition team understands the challenges of foreclosures, as well as the real estate aspects of value-added property management, there is every reason to believe that the process will produce optimal results for all parties.
Bill Goeke is senior vice president and director of the Central Division of PM Realty Group, a Houston-based commercial real estate firm.