Working the Distressed Market

By Keat Foong, Executive Editor

The good news: There are still multifamily distressed assets available for sale. The bad news: There is no great firesale a la the RTC days-, meaning the bulk of these assets remain at market-rate. “We are certainly not suggesting there are no distressed opportunities left, but many buyers, relative to their expectations about how much distressed product was going to enter the market and were expecting waves of quality assets at discounted prices, are being disappointed,” says Steve Weilbach, senior managing director and national head of multifamily at Cushman and Wakefield.

Nevertheless, Weilbach and other experts note there are still relatively well-priced multifamily opportunities available if buyers are willing to look at older assets in secondary markets.

Data from Trepp LLC show that the stock of troubled commercial real estate loans currently stands at $18 billion. Bank and CMBS mortgages that are delinquent or in default total $16.8 billion, while $1.2 billion of CMBS mortgages are in special servicing. The amount of debt that is non-performing is not quite as high for multifamily as for other property types. However, there are still buying opportunities in the distressed sector, agrees Matt Anderson, managing director at Trepp.

Weilbach points out that much of the disappointment of investors with finding distressed opportunities stems from confusing the words “distressed” and “discounted.” Many properties or loans today are correctly categorized as “distressed” from the perspective of their most recent buyer and/or borrower. However, the prices fetched by those “distressed” assets in the current market may not necessarily be “discounted” as a result.

At the most general level, note sales rather than property sales offer the greatest potential for discounts, observes Weilbach. The primary reasons for this of course is that direct note purchases are a much more challenging proposition: many note acquisitions have to be undertaken without full due diligence, and the successful buyer may still have to go through an involved legal foreclosure process with uncertain timing and outcome. “There continues to be uncertainty regarding when and whether the investors can take title to the property when they buy the note,” says Weilbach.

Notes tend to trade at a discount to property values due to the transaction costs and time to obtain the fee interest, says Ken Rivkin, co-CEO of Auction.com Commercial. “If a property is well marketed, it should price at market levels,” says Rivkin. “The discount to the real estate value varies by jurisdiction and can range from essentially nothing in Texas to low double digits in judicial states,” he says. For better assets where investor competition for the fee is stronger, the discounts may even be negative—that is, a higher price can be obtained for the note rather than the real estate, says Rivkin.

Underperforming properties

In contrast to loans that can be purchased at low prices, troubled multifamily properties may generally be more difficult to find today simply because the multifamily markets have recovered in the prime locations. Lenders are also preferring to spend time to improve their properties before selling them in order to obtain higher prices. Unlike in the early 1990s following the savings and loans crisis, banks, for example, may not be pressured to immediately sell their assets. They can appoint receivers to stabilize the assets before returning them to market via a broker such as Cushman and Wakefield. And especially in the case of the larger properties located in top markets, lenders have the time to optimize the property values.

As far as sources of assets, bank- and conduit-possessed apartment loans or properties may be where the predominant opportunities are, since Fannie Mae and Freddie Mac and the life insurance companies have relatively low default rates, notes Trepp’s Anderson. An examination of the Trepp data reveals that CMBS distressed assets tend to be concentrated in the metro areas, says Anderson. They are also more likely to be highly leveraged and more likely larger portfolio deals. Troubled bank loans are scattered more broadly across the country and may tend to be smaller in size.

The greatest volume of lender-held multifamily assets are still found in the major metropolitan areas simply because these markets are larger, says Anderson. However, within those markets, the more desirably priced opportunities will have to be uncovered outside of the core city in surrounding areas, as in outside of Manhattan or outside downtown San Francisco. Atlanta, Las Vegas, Phoenix, Riverside, Calif. and Miami remain among cities with sizable amounts of loans that have gone south, Anderson says.

Trepp data also shows that the preponderance of CMBS distressed assets are located in the New York, Atlanta, Houston, Las Vegas, Phoenix and Riverside markets, while Chicago, Los Angeles, Miami and South Florida still carry the bulk of the bank-owned troubled real estate assets.

As for soured condo conversion loans, Anderson suggests that such bank-owned debt is more likely to be found in the greatest numbers in New York, Chicago, Los Angeles, Las Vegas and South Florida. These condo loans “are picked over to some extent, but they are still out there,” he notes. Anecdotally, there are still conversion loans that have defaulted and not yet been foreclosed upon. Furthermore, investors taking note of an improving economy are becoming more likely to take on mothballed projects today, observes Anderson.

As institutional buyers are driving demand for quality multifamily properties of size in primary markets, Weilbach says that buyers seeking less competitively priced assets may want to explore non-institutional properties in secondary and tertiary markets if they are “looking for opportunities to purchase where fewer people are looking. Non-core assets in secondary locations do not meet the criteria of most institutional investors,” says Weilbach. “Less sophisticated and shallower markets can lead to better pricing.”

Desirable secondary markets that contain a relatively strong inventory of potentially distressed product, says Weilbach, include Atlanta and adjacent Southeast markets; Phoenix; several markets in the Midwest, excluding Chicago, but including St. Louis, Mo., Indianapolis, Ind. and Columbus, Ohio; and markets in Texas outside of the main cities of Dallas, Houston, San Antonio and Austin.

“The more troubled markets are generally the sun and sand states along with pockets in the Midwest,” agrees Auction.com’s Rivkin. The harder hit cities include Atlanta, Phoenix and several Texas metropolitan areas, says Rivkin. He argues, however, that among property types, Class C assets have less interest and tertiary markets have been challenged by lower transaction volume, which makes pricing levels more difficult to determine. “In these markets, there may be both a willing buyer and seller, but both want a market price which is challenging to discover,” he says.

Companies and institutions that are involved in the distressed market generally have some form of online exposure to the properties for sale. There are also auction websites that buyers can access. Jones Lang LaSalle, for example, has an auction website. Auction sites may need to move a huge amount of inventory in a short period of time and may offer greater discounts just because the buyer has limited ability to conduct due diligence or otherwise examine the properties.

Some experts recommend approaching regional and local banks first before the CMBS special servicers. As opposed to special servicers, of which there are only a handful in the country, there is a deep list of banks across the country that investors can access, says Anderson. “The smaller regional and community banks are a better source [of assets],” he says, adding that regional and local banks hold by far the most maturing loans, possibly even more so than the national banks.

As far as approaching banks, “they do not want cold calls,” advises Anderson. Investors need to do their homework on what the bank needs and approach them with solutions in mind. “The very largest banks are getting constantly barraged with inquiries,” says Anderson.

Regarding special servicers, one downside to approaching such venues today is that they may want to hold on to the distressed assets themselves, and may not be as interested in selling their entire inventory. “Many special servicers are transitioning to being fully diversified financial services companies with their own brokerage asset management and/or equity capabilities,” says one source. They can therefore, for example, raise equity to purchase the properties.

Palatine Capital Partners sponsors a distressed debt fund. Alex Hurst, founder and managing partner, says that the supply of troubled multifamily product is not as “rich and robust” as two years ago, although there is still a “steady stream” of offerings. Most recently, the company announced it sold a 320-unit apartment property, the Apartments at Stonebrook in Nashville, in December for $14,562,665. The company said it had acquired the property for $7 million in May 2010. According to Hurst, the property was CMBS-owned and listed through an investment sales company.

In Hurst’s view, the best opportunities for acquisitions lie with Fannie Mae and Freddie Mac products, which are listed through brokers—
at least in terms of the attractiveness of the pricing. Fannie Mae and Freddie Mac, he says, are more likely to sell aggressively, compared to the special servicers.

In the final analysis, keep in mind that deeply discounted multifamily properties and loans may be hard to find as the multifamily sector is the most desirable investment among commercial real estate sectors. “Quite often, we get asked the question, ‘where can we buy good, cheap multifamily real estate?’” says one industry observer. “That is impossible in today’s market.”