GUEST COLUMN: Evaluating Distressed Property

By Matthew Cummings, MC Squared Consulting“These are the times that try men’s souls.”Although the situation today in no way is comparable to Thomas Paine’s take on the American Revolution, our economic crisis today truly is “trying our souls” again. A variety of actions have been taken by government to address the underlying problems created by the housing bubble and subprime lending fiasco with little to no effect. Nothing, so far, has been successful, in large part because of the reluctance to purchase existing housing and commercial property.  In theory, then, if a majority of available properties were purchased and inventory considerably reduced, that should signal the start of a recovery.Analysts typically are reluctant to predict precisely when a recovery will begin. However, all agree that reduction of inventory is the key. Since current thinking suggests bottoming out likely is underway, solid opportunities should exist now for investors and buyers nationwide. But, unless a comprehensive analysis on every aspect of each property’s intrinsic value is performed by experts, serious and costly mistakes can—and will—be made.Intelligent analysisThere are a number of reasons why properties are offered at significantly reduced prices.  Quite often it’s because the property was never really worth the initial investment. It is imperative buyers are absolutely certain they have conducted an intelligent property analysis before attempting to make “a real steal,” but that is a complicated, multi-disciplined process…something not everyone is prepared to supervise.By examining a fictitious distressed property sale we are able to demonstrate the multiple steps that must be addressed in such intelligent analysis and how each functions as part of a whole.For this exercise, our property is a multi-family project on the southern Gulf Coast of Texas with three buildings of eight condos each. The first two are 80 percent completed with four units pre-sold at an average price of $400,000 apiece. However, the two buildings have been dormant for six months and have sustained wind and rain damage, and an additional $750,000 is required for sewer connection. The property is being assessed back taxes and approvals for the third building are about to expire.The original developer has declared bankruptcy and the bank that now owns the property is inundated with liens from subcontractors and suppliers. As a result, the bank is offering the property at a great price.The potential buyer believes he can buy the property at 50 percent of its original value, but must determine if he would be able to realize a healthy profit if he finishes building the project and sell his units at a significantly reduced price. To accomplish this, the buyer must be prepared to guide each and every component, which will involve a number of key elements.Property and building analysisKey to the buyer’s research are current and projected market demand in the area where the property is located, along with the price range at which the properties can be sold. There are several local real estate analysts, but this is a case where a prospective buyer should seek the services of an experienced market analyst who understands more than just what is occurring in a particular market. He will need a clear vision of where this market is heading, and when he’ll be ready to sell his completed units.If it is determined there is a potential market for the property and its offerings at a price point the buyer will need to meet, there will be the additional need for analysis of the buildings themselves to ensure they have not suffered potentially serious damage and were built to proper specifications.Construction managementFollowing all analyses and the decision to move forward, the buyer hires a construction management expert who can review all contracts, speak with the subcontractors and suppliers holding liens, and attempt to negotiate better terms with all parties. This construction manager also would review all the plans to certify that the structures were built according to plan and search for potential mistakes in the original drawings. He then would explore options for value engineering the next building and the potential downsizing of interiors in the already-built condominiums, if called for.The construction manager must also bring in a quality forensic engineering firm to conduct a complete examination of the building, infrastructure and sewer connection to ascertain their structural integrity and that they were built to code. This review also should involve examining the water and sewer system yet to be built and, potentially, a study into re-engineering the buildings more efficiently to meet updated standards.  Re-designing the projectNow the process must be turned over to an architect attuned to designing to market conditions. The architect would review the existing buildings, armed with the analysis provided by the engineer and construction manager, to lay out a re-design program that brings the failed property to its optimum look and feel.Armed with answers regarding the market, existing buildings on the property, construction management and projected future costs, the buyer still must determine whether he can meet the recommended price point for these condo units. The answer generally must be provided by a specialist who researches all the factors that have been brought into play and then creates a bank ready pro-forma that demonstrates the project can indeed be viable…and the price that should be offered for purchase of the property.Additional concernsThe purchase analysis must factor in the full cost of approvals, legal expenses, construction, re-design, engineering, marketing, public relations, capital carry, property management, security and myriad other factors. And then there’s the issue of the four purchasers who bought units during pre-sale for $400,000 apiece.Let’s say our just-completed analysis dictates that units now will sell for a maximum price of just $290,000. A thorough pro-forma might tell our buyer he could buy each property back at the original $400,000 price yet still make a profit IF he offers the bank $2,400,000 for the property as is.The buyer then would hire an experienced construction and development lawyer to seal the deal and, once accepted, launch his project with the construction manager he retained during the initial investigation.While this was a simplified fictional exercise, the actual process could well be more complex and require additional elements; but this is how intelligent analysis of a potential distressed property should be conducted. Done properly, the process likely will generate very satisfying results.  Matthew Cummings is the founder of MC Squared Consulting in Ponte Vedra Beach, Florida