How to Acquire Distressed Real Estate Assets
by Adam Lubkin
November 24, 2009
First, I would like to thank my good friend Matt Adler for allowing me to write a short blog on his site. I enjoy Matt as a friend, as a real estate professional, and I always appreciate his insight and views on real estate.
My company, Ibis Development Group, was created three years ago specifically as an outsource acquisition arm to approximately 30 developers throughout the United States. We locate, analyze, bid and hopefully close on all types of assets, primarily commercial real estate. Although we look at assets throughout the United States, recently we have had success within our home state of Florida with note and mortgage sales. The primary sources of these note sales are local and regional banks, large real estate funds, special servicers and attorneys.
Here are the top 5 frequently asked questions by our developer/owner-operator partners and our responses:
1) Do you analyze the note’s asset or just the discount from the note’s face value? We always analyze the underlying value of the real estate asset. In fact, we rarely ask about the mortgage’s face value. Obviously, we will eventually find out the asset value, but we want to first focus on the asset itself, not necessarily the discount being offered. Frankly, the discount offered is a secondary consideration. We prefer REO’s or deed in lieu scenarios. Most developers shy away from litigation, but that’s a real risk when playing in this arena and everybody has a certain level of risk tolerance.
2) What the best advice you can give when talking with the banks? Be considerate. Most of these bankers run into “tire kickers,” people who need to raise money in order to close, and inexperienced wannabe developers who talk a big game and just want to take advantage of a distressed situation. Remember, most of these bankers are also the same people who originated the loan so this process is very uncomfortable for them. Also, don’t assume that you are the only developer in town or the only company with cash. Its a very competitive marketplace, and there is incredible wealth out there and plenty of people who can close a deal. My advice is to show credibility through recent closings; be completely transparent and honest by showing your analysis, assumptions and ROE (Return on Equity); and be prepared to show proof of available funds. Lastly, act like you are the great wide receiver Jerry Rice – If you score a touchdown, just give the ball to the ref, don’t showboat and run quietly to the sidelines!
3) Are transactions happening? Absolutely. Deals ARE getting done quietly. Banks aren’t going to publicize the fact that they are selling bad loans, but they are. Furthermore, if you expect to buy more loans in the future, don’t brag about your most recent acquisition – It’s bad business. There is no upside for developers to spam e-mail the world or advertise about their conquests.
4) What assets are trading now and how long will this buying cycle last? We are seeing about 75% multi-family and broken condos. Rarely do we see Class A or B+, mainly B’s and C’s, however, they are abundant right now. For a great multi-family developer with cash, this is their cycle. Office loans are probably next in terms of abundance. As the recession continues and unemployment rises, certain office buildings will continue to suffer badly. We believe there will be great acquisition opportunities in the office asset class. Retail, hotels/hospitality and industrial deals are scarce but we predict deal volume will increase within the next two to three years. Overall, for a strong developer with large cash positions, this buying cycle will last until at least 2012.
5) What do you tell “traditional” developers who want to play the distressed assets game?First, I tell them that these are not traditional asset purchases. Typically, it’s not a pretty stabilized asset, capital expenditures are almost always necessary, it’s probably been mis-managed for some time, and might not even have a cash flow. You really have to look at the asset as a commodity being bought way below replacement value. Terms to the seller are very important. Strike while the iron is hot. Close quick. Make sure your LOI has a short due diligence period. Hire great attorneys. Don’t give the source a reason to change their minds or go to another buyer. We also strongly recommend that you DON’T play games with the seller. It’s a bad practice to re-trade your offer unless it’s truly justified. And if the asset is not your company’s strength either get a JV partner or simply don’t bid on the asset.