Receivership Pitfalls in Property Management

In any economic downturn, it is common for industries to look at additional income streams, and property management companies are no exception. In this cycle, for example, many are looking at receiverships as an alternative to their traditional management assignments.

But just because everyone seems to be jumping on the bandwagon does not mean that every company can, or should, take on distressed assets as part of their portfolio, industry experts caution.

“There’s no free lunch; if it were easy, everyone would have automatically added it to their menu of options,” points out Charlotte, N.C.-based Crosland’s Residential Division President David Ravin, who, despite having experience in the process, notes that it is not for the faint-of-heart.

For one, there are a variety of relationships between a receiver—appointed by, and acting as an agent of, the court—and the manager. Some receivers, for example, encompass their own management companies and may choose to handle both the management and the receivership. And in some cases, property management companies have taken on the receiver role.

In other situations, an entirely new management company may be brought in—often on very short notice. “The biggest difference is, it’s a short-term window; the receiver is not there looking for long-term value creation but is instead looking for maintaining something on a much shorter window,” says Ravin.

If the existing management firm doesn’t have any conflicts of interest, a receiver may choose to keep the company on the property to provide a certain level of consistency for all parties. However, “if the company were related to the owner or if they have a lot of business relationships—maybe this is one property out of 10 that they’re managing all for one owner—then it’s probably going to be a bit of a conflict, in which case we would either manage it ourselves or we would employ another management company,” explains Bill Hoffman, president of Trigild, a non-performing commercial loan specialist that offers receivership, management and disposition services.

In any situation, though, the receiver needs to understand that it is neither employed by the lender—though the lender can choose its receiver—nor is it a receiver for an entire ownership company, points out Hoffman. So while the receiver acts in the best interests of the lender’s assets, the lender cannot direct any of the receiver’s actions.

Managing a property in receivership

Although most management companies don’t do receiverships on a consistent basis, many firms take on this type of asset during a down economy. However, Hoffman cautions against “free receivership,” pointing out that it’s important to recognize that managing a property in receivership is different than managing a more traditional property.  An equitable remedy rather than a legal remedy, receivership has very few code sections and is oftentimes quite generic, he points out.

“I would urge some caution to folks stepping in on a receivership,” adds Crosland’s Ravin. “You have to have some expertise that you don’t necessarily carry or have on staff when you’re managing a traditional property.

“We learn lessons each time [we do it], and I think we are a little more cautious of taking on those roles with some experience behind us,” he adds. “We learned enough to ask some more questions and make sure we’re not doing something purely for a fee without understanding what’s really going to be required during that process.”

In fact, one of the most common complaints Hoffman has heard from his lender clients is either that managers are charging too much for their receiver fees or that hiring outside legal counsel adds too much to the cost.

And while a property management company doesn’t necessarily need to have had prior experience working with receivers, they do need to understand the relationship between the parties. While the property is in receivership, for example, the property manager must report to the receiver and be careful not to interact with the bank, cautions Hoffman. “One of the very first things we tell management companies is, if they’re working for us as receiver, they may not, under any circumstance, ever call anyone at the bank. That exposes them to very serious lender liability.

“We expect them to know how to manage a property according to what we want to be done,” Hoffman adds. “It would be like any owner [saying], ‘here’s what we want to achieve with the property; here’s the way to do it; here’s the money we’re willing to spend. Now you go out and do your job.’”

Acting quickly

Getting control of the property and contacting all parties involved as soon as possible is crucial. In addition to contacting every resident, management needs to communicate with utility companies and any other vendors with which the property has had a relationship.

Oftentimes a new manager will call a meeting for all of the residents to explain what it means for a property to be in receivership, as well as what is expected to happen.

“Tenants do become concerned because they associate receivership with a bankruptcy,” notes Ravin. “I think that a receivership starts to send a signal to the community that’s maybe not fully understood. They anticipate that this is the first step of a bad thing,” he says, adding, “occasionally, we’re seeing relief that someone is stepping in to correct the issue.” It’s also important to meet with existing on-site staff.

Often, within 48 hours, residents—and employees—will notice improvements, demonstrating that things are being taken care of, “and nothing has changed, as far as they are personally concerned, other than the service is usually a little better,” notes Hoffman. After this initial period—during which residents need to be informed where to send rent—“we want to keep a very low profile,” notes Trigild’s Hoffman.

On the financial end, seizing control of the property’s bank accounts immediately is crucial. “We try to get on site and understand what the property’s operating accounts are: where are they? Who has had access to them? How much money is in there? Is everything balancing? It’s a financial audit fairly quickly,” says Ravin.

In many cases, managers are left without full financial records, and available records may be inaccurate. But for managers experienced with running multifamily communities, “it doesn’t take long to prepare a rent roll, to know if the rents make sense, to know if the expenses make sense,” points out Hoffman. In addition, he notes, employees that are kept on-site can provide accurate information on asking and effective rents, as well as potentially problem residents.

Life issues must also be addressed immediately, points out Mike Kelly, president and co-founder of Caldera Asset Management, which specializes in multifamily consulting and turnaround services.

“If it’s a property that was in physical distress and the dollars were starved, that generally means there are life-safety issues all around,” he notes.

Lights, sidewalks and security are just some of the aspects that need to be addressed, along with any code violations. “If the owner didn’t have enough money to pay the mortgage, then they sure didn’t have enough money to keep up with all the physical issues, which generally triggers some sort of code violations,” Kelly points out.

Taking care of these issues is also often what reassures residents more than anything else. “It’s very rare that beyond the first couple of days that anyone cares [that we’re there]. That’s part of our job—to make a really smooth transition, be invisible and run the property well,” says Hoffman. “That’s the interest of the lender; obviously the reason they put the receiver in is they’re not happy that they haven’t been paid, but [what’s more] they don’t like what’s being done to the asset. That’s the only security they have for that mortgage, so they want to be sure that’s protected.”

Once they have control of the property, managers should take a physical inventory of the property, which includes determining how many units are online and how many units are occupied. “It’s different than taking over a property for lease-up where you’re trying to get everything stabilized and reap the benefits after the train is on the track,” says Ravin. “In the receivership role, you put in a lot of effort to get the property secured … You’re a first responder, and you try to stabilize the patient.”

Maximizing value

“We, as owners ourselves, are always trying to say, ‘what can we be doing to increase the appeal of the property?’ and that’s not necessarily the role when you’re in a receivership,” Ravin notes. “It’s much more about security and procedures.”

Several years ago, it was unusual for receivers to sell properties, but it has become more common as of late. From the lender’s standpoint, it is oftentimes advantageous to sell the distressed asset as quickly as possible.

For these assets, “don’t try to over-improve them,” advises Kelly. “Certain people are much better to manage this stuff than your everyday household property management names. … A lot of those guys aren’t designed to be managing these completely dilapidated properties. They just don’t make any money, and that’s not their skill set.”

If the asset is in a securitized pool, the existing mortgage may be restructured so that the new owner can assume the mortgage at a different amount, making financing immediately available, points out Hoffman. “That makes a huge difference in the price we get for the property. A receivership needs to be able to negotiate the liens pretty well and understand that the ultimate goal is to maximize the value on the property.  You have to be able to … understand what we need on this property; what do we need to maximize the value or minimize the loss?”

In other situations, the lender may prefer to foreclose on the property, perhaps to hold it for a while in the hopes that the value will improve.

In either situation, “the best you can do is give clarity of information,” points out Ravin. “You can’t necessarily get into a lot of capital expenditures or property improvements to reposition [the asset]. What you’re really trying to do is sort through and clarify the information, which someone else might have an interest in buying out of receivership.”

For those assets that are in a more manageable state, it’s possible to create value by leasing them up, suggests Kelly. “Your clientele is going to be dramatically better once you solve the physical issues, versus if you try to lease a property that’s in disrepair,” he notes.

He suggests  focusing on making the front entrance appealing. When prospects drive by a building, if the property “looks dark, dingy and dangerous, no matter what kind of sales job you do, you’re not going to get the right clientele in there,” Kelly points out.

In either case, Hoffman cautions against being unrealistic. “If the property were worth a lot more than the mortgage, we probably wouldn’t have it to begin with, so whenever anybody says they … make them worth a lot more money, that’s rarely true. The reality is, you have a problem property.”

In such cases, then, the repositioning of the property is simply in its management, and any money that is spent must have an immediate and obvious return. “You’re never going to turn it into a perfect property because rarely would the money ever come back,” Hoffman adds. “That’s giving the lender an expectation that’s kind of foolish.”

Dos and don’ts

Industry experts provide some key tips for managing a property in receivership.

• Seek legal expertise, suggests David Ravin, president, Crosland’s residential division. “You are counting on the receiver to get you through the court system. I would recommend legal counsel on your own end to make sure you’re not assuming a liability that you didn’t know about.”
• Be careful not to underestimate the time and effort it’s going to take to get certain properties back up to speed.
• One size does not fit all. As Mike Kelly of Caldera Asset Management points out, “At the end of the day, you may be losing money because you’ve got so much of your back-office people that you’re paying, spending so much time on assets, on bringing them up to speed, that you’re actually losing money on deals.”  Also, not every property management company is suited for every type of deal.
• Combine speed with knowledge. “One without the other is dangerous,” points out Trigild President Bill Hoffman. “There are receivers who can be very quick and jump in and spend a lot of money, but it wasn’t necessarily the best way to spend it. Or there are some who study it for a long time and collect fees for a long time.”
• If you pick up a less-occupied property, get paid on a per-door basis versus a percentage of collections, suggests Kelly. “There are going to be times when collections are going to be miniscule, and you may get a very high property management fee, but the fee times nothing is still nothing,” he says.
• Do not discuss receivership assignments with the press. Banks and receivers do not like publicity on troubled properties.
• Be cautious about taking on receivership assignments, warns Ravin. “You have to come at it with a different perspective, using different resources.”