Managing Distressed Debt and Assets: 4 Steps
- May 27, 2020
It’s impossible to know when markets will return to normal, but one thing is clear: the current economic crisis has had an immediate impact on commercial real estate that owners, operators, investors and lenders are struggling to understand and manage.
Amid rising late CMBS payments and a looming wall of maturing debt, some may be inclined to revisit their playbooks from the Great Recession. However, there are some important differences between the last financial crisis and what is unfolding today. The 2008 crisis was regulatory-driven and led to a significant impact on the banking and CRE industries, as firms faced maturing CMBS obligations, an inability to refinance and the loss of underlying collateral value.
Today’s crisis stands in stark contrast because it has impacted virtually all industries with its transaction-driven nature. And while securitization is certainly still a concern, with over $4 trillion of maturing corporate bonds coming due in the next five years, the biggest issue facing the CRE industry now is diminished cash flows from late or absent rent payments and overleveraging as companies tap credit lines.
The hope is that as soon as employment numbers rebound, many of the pain points CRE is experiencing will self-resolve. Even so, a lot of damage to key indicators has already been done, meaning that a wave of restructurings is likely hurtling toward the industry.
To cope with the situation, finance executives—regardless of the health of their organization’s balance sheet—should consider crafting a distressed debt and asset strategy that can help mitigate risk and maximize the value of assets during these challenging times. Four key focus areas to consider:
- Due diligence. This stage encompasses identifying and assessing data, financial and operational strategies based on value and risk drivers, and potential opportunities and challenges. Assessing operational efficiency and managing loans and assets to stabilize and enhance value efficiency may require particular attention from owner-operators, while investors and lenders may need to focus more on estimating and recovering value in an illiquid marketplace.
- Strategy planning. In this phase, CRE executives should devise a strategy to manage distressed assets, perform scenario modeling, and assess funding and returns. Part of this may entail analyzing distress levels across industries and creating an acquisition strategy that considers individual loans or properties, portfolios of loans or assets, or entire institutions.
- Implementation. Executives will also need to create a process to put strategies into action, consider roles and responsibilities, and access capital. In some cases, this may entail deploying fintech solutions to address challenges around the administrative, accounting and tax demands of today’s market. That includes solutions that help manage the sudden increase in lease modifications, deferrals and abatements which many organizations are now addressing.
- Maximizing value. Finally, it will be important to take steps that can maximize the value of distressed debt and assets by activating the strategies developed during the planning phase, which could include tenant revenue and expense enhancements. Devising an exit plan, finding a strategic buyer or partner, and recapitalizing or refinancing loans will also be key activities to lean into, depending on whether a reorganization or bankruptcy filing is called for.
For now, the CRE industry is evaluating portfolios to understand potential risk exposures. Job losses and the impact on the consumer will have a dramatic effect on liquidity and borrowers’ ability to meet their contractual obligations. Some lenders are working with borrowers to help them weather this storm’s impact on office, retail, multifamily and hospitality; retailers are starting to file for bankruptcy protection; and investors are waiting on the sidelines for the right opportunity to acquire distressed debt and assets.
As challenging as this crisis is, its full impact has yet to emerge. Now is the time for finance executives to dig in and prepare themselves for the distressed scenarios they could face.
Steven Bandolik is a managing director with Deloitte Services LP and the leader of Deloitte’s Distressed Debt and Asset Services practice, which relaunched in the spring of 2020. Bandolik advises clients in capital markets (debt and equity), corporate finance, mergers and acquisitions, investments, strategy, restructuring and reorganization, and asset recovery. Bandolik brings more than 35 years of effective, hands-on real estate investment, finance, development, and asset/property management experience, both as a leader and as a strategic adviser.