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Managers of Distressed Centers Recruit Tenants to Help Their Cause

When Woodbury Corp. took over the management of a retail center in foreclosure in Utah, the firm lacked the information it needed to address an assortment of property management issues. Woodbury wasn’t provided with a current tenant roster or documentation detailing whether tenants had been keeping up with their rents.

The manager in charge of the asset attempted to develop a relationship with the tenants to obtain the much-needed information. After resolving the most pressing management issues on hand and gaining the tenants’ trust, he addressed the question about rent payments.

“What we find is a lot of times at these properties nobody has been doing anything in terms of basic maintenance,” says the manager, Jeffrey D. Bettinson. At this particular center, “the tenants were frustrated because they had been living with that situation for a while. After meeting with them face-to-face and showing them that things are getting done on the property level, they have been more willing to share information on their [rent] status and whether they’ve been current or not.”

The manager quickly learned the lay of the center with the tenants’ help. The majority of the tenants have been honoring their lease agreements. In fact, one of the tenants plans to buy the property from the lender and is considering hiring Woodbury Corp. as the permanent property manager.

When a property manager takes over a retail center in a receivership or one that has gone through foreclosure, the process can often be chaotic. In many cases, management companies take these assignments on short notice, with little time to research the assets. The available information about the center on the lender’s books might be dated, going back to the day the lender closed the original loan. Sometimes, the previous owner tries to do the right thing by providing as much information as he can to the new manager to make the transition easier for his former tenants.

In many cases, however, after losing the property the former owner disappears from the picture, with little concern for the asset left behind, says O. Randall Woodbury, vice president of property management with the Woodbury Corp., a Salt Lake City-based commercial real estate services firm, and president of the Institute of Real Estate Management (IREM). Woodbury Corp. currently manages 9 million square feet of retail, in addition to 1.5 million square feet of office space and nine hotels. Woodbury says that in many cases, the tenants might be the best sources of information the new manager has, which is why it’s important to gain their trust and develop a relationship with them early in the process.

Overnight assignment

When Woodbury Corp. had to take over the management of a foreclosed strip center in the Salt Lake City area earlier this year, the tenants proved instrumental in bringing the firm up to speed on the physical condition of the property and on what was going on with the rent roll. The key was getting them to trust Woodbury Corp. as the new manager and show them that it would become a reliable, conscientious landlord.

The property in question is a 22,000-square-foot shopping center that was built at the height of the construction boom in 2007. Though Woodbury believes the center has great long-term potential because of its location on an access road that connects to the Interstate, it was built in an area that in 2007 was just beginning to grow and was badly hit by the recession. Most of the property’s dozen spaces have been leased by service-oriented tenants, including a day spa and a dentist’s office. The property had never been more than 60 percent occupied. The remaining 40 percent of the spaces have sat vacant since construction was completed and would require significant investment in tenant build-outs in order to attract new retailers, Woodbury notes.

The developer of the center had been struggling with the mortgage almost from the day it was built, having been hit with the double-whammy of too much leverage and an extremely difficult retail sales climate. After three years, the lender, a regional insurance company, was ready to take the center back. The lender’s attorney originally contacted Woodbury Corp. in February of 2010 about potentially taking over the management of the property. Due to some legal wrangling between the lender and the original owner, however, the assignment did not materialize until May.

“That’s one of the things that’s inherent [in this business] — you don’t usually have much warning to do an investigation of the property,” Woodbury says. “And when they give you the go-ahead, a lot of things have to happen very, very quickly.”

Finding a roadmap

An additional challenge for Woodbury Corp. in this case is that the lender offered little information on the existing rent roll and property issues. Some of the tenants listed in the lender’s loan documents had long ago vacated the center. It was impossible to determine whether the tenants that were still there had been making their rent payments. And outside of an obviously neglected lawn, none of the property’s physical problems were visible to the naked eye, notes Bettinson of the Woodbury Corp.

To get a better sense of what was going on, Bettinson started his managerial duties by getting acquainted with the tenants. After explaining to them that Woodbury Corp. would now be the property management agent for the center and assuring them that the firm had a long track record in working with local retail properties, he asked if there were any issues with the center’s operations that the tenants wanted help with.

There turned out to be quite a few problems. Many of the lights in the parking lot did not work, the air filters on the HVAC system had not been changed in years, and the system was about to stop working because of lack of maintenance. In addition, the sprinkler system had not been inspected. The previous owner of the property had apparently given up on maintaining the center, and for many months the tenants had to tend to most of the cleaning and management duties. As a result, they were happy to explain to Bettinson what was going on and show him where all of the center’s systems had been located so he could start fixing existing problems.

Once the tenants realized the new management company was serious about helping them and maintaining order at the property, it was also easier to have conversations with them about their rent payment status, notes Woodbury.

“It’s really an opportunity,” he says. “If you’ve got somebody who hasn’t been making their rent payments, you really have no way of knowing; they can just lie to you. But when they see that you are taking active steps to help them at the property, most people tend to respond by being pretty honest and forthright.”

It turned out one of the tenants had trouble keeping up with the rent and wanted to work out some form of a concession package with Woodbury Corp. That case is now under consideration. The firm also discovered that one of the original tenants had subleased its space to a different operator without the lender’s knowledge and then had gone out of business. The company is now working to document the arrangement and make it official.

So far, only one tenant has proven to be a problem for the new manager—the store’s owner had written a bad rent check and shown that it might not honor its commitments. Woodbury is considering whether to have another conversation with the tenant or initiate eviction proceedings.

Unexpected twist

Some of the tenants, however, stepped up to the plate when the property was going through a rough patch. After the original owner all but abandoned the center and before Woodbury Corp. assumed its managerial duties, one tenant, a dentist’s office run by two brothers, took the lead in handling day-to-day operations of the property, arranging cleaning services and communicating with vendors. Remarkably, that tenant is now in talks to purchase the asset, having figured out that this particular piece of real estate could be a good long-term investment.

If the sale goes through, the tenant will likely purchase the center at an 11 percent capitalization rate, a steal even in today’s market conditions, according to Woodbury. (At the height of the real estate boom, strip centers traded at cap rates in the 6.5 percent to 6.9 percent range. Today, strip centers sell at an average cap rate of 8.0 percent to 8.5 percent.) The sale appears to be pretty much a done deal at the moment, as the lender has instructed Woodbury Corp. to discuss the potential concession package with the would-be buyer.

“It appears to us that even just based on the existing occupancy, the property will cash flow right out of the shoot,” Woodbury says. “They are getting a really good deal.”

The tenant has also approached Woodbury Corp. about potentially coming in as the permanent management agent for the property.

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