Short sales & loss mitigation: distressed commercial real estate REO properties help investors buy distressed debt on commercial properties that are headed for foreclosure—the goal being to resell the property for a profit or make improvements and hang on to it for a while before selling. Bankruptcy can place the property in a receivership for months, if not years. "We're seeing experienced investors who backed out two years ago when cap rates were 6.5 percent are returning now that cap rates are around 8 percent." A favorable capitalization rate, or cap rate—the net operating income divided by purchase price—and a solid tenant may not be enough.
Commercial Real Estate: Finding a New Stream
Success in commercial real estate today requires looking at your skills and your market in a new way.
By Mariwyn Evans
reprinted courtesy Realtor Magazine March 2010
Commercial real estate will come back. But in the meantime, you still have to make a living. What does it take to get business today? You may have to leave your comfort zone.
"It's not glamorous, and most people won't do it, but it's the people who are willing to work hard and prospect who are prospering," says Robin Webb, CCIM, CPM®, vice president of statewide operations for Coldwell Banker Commercial NRT in Maitland, Fla. "There are always people with current needs to sell or lease. You just have to be ready to seize those opportunities."
Of course, to seize the opportunities that exist in your market, you also have to be ready to look to new sources of business—and be willing to expand your skills or business model to meet your clients' needs. Perhaps you can help banks unload REO properties, work with tenants who need to renegotiate their lease, or become a court-appointed receiver (see "You Can Be a Receiver," page 32).
Here's a look at how some practitioners are making the most of a down market.
Create a Foreclosure Team
The growing pool of distressed commercial property makes it the obvious choice for new business. That's not to say that getting the business is easy.
Through November, the total value of distressed U.S. commercial real estate was $140.5 billion, up 44 percent from June, according to data from Real Capital Analytics, as reported in the Distressed Commercial Real Estate Journal. That figure includes properties in distress, foreclosure, and lender REO.
But given the overwhelming volume, don't expect a banker to call you back about taking on just one or two listings, Webb says. Instead, organize a team of service providers who encompass management, leasing, and sales. This makes bankers' lives easier by providing a single point of reference, he suggests.
That's exactly what Patricia Lynn, CCIM, has done. Lynn is a partner with the newly formed Recom Global LLC, based in Phoenix. "We're offering the entire range of services banks may not have the staff or capacity to handle," Lynn says.
If you don't have all the necessary skills within your company, she suggests that you find partners and develop a team structure before you approach lenders.
Another sweet spot on the distressed property spectrum: short sales. Sure, they've been the bane of residential brokers because so many of the deals never close or take so long that buyers walk away. But many banks have learned their lesson and are seeking to close commercial short sales in less than six months, says Jennice Doty, with KW Commercial in Phoenix. "Short sales still require additional time and effort, both in providing financials to the bank and in negotiating the loss mitigations. The good news is that banks are more willing to work with clients to expedite the process."
Doty's also seeing a flood of requests for proposal from Freddie Mac, Fannie Mae, and the FDIC to handle the property management, leasing, and sale of portfolios of foreclosed properties. She's made some of her government agency contacts through residential practitioners who've done REO work. "The same asset managers who handle residential often oversee commercial portfolios as well," she explains.
Working with distressed property owners to renegotiate their loans with the bank is another way to find work, says Suzanne Miller, CCIM, CPM®, vice president of marketing with Colliers Bennett & Kahnweiler in Denver. Brokers and property managers have the knowledge to analyze operating income and compare market rents so lenders can understand the property's actual value, she suggests.
Buy the Debt, Get the Property
Another profitable, if challenging, way to benefit from the downturn is to help investors buy distressed debt on commercial properties that are headed for foreclosure—the goal being to resell the property for a profit or make improvements and hang on to it for a while before selling.
That's the business model for Ted Hill III, CCIM, vice president of Vision Ventures of Carolina LLC in Charlotte, N.C. "We usually focus on distressed debt collateralized by distressed properties. These are problematic loans backed by properties with high vacancies, incomplete construction, or other major issues," Hill says. He looks for good locations and pricing at about 60 cents on the loan dollar for his all-cash deals.
The most challenging thing about buying distressed debt is knowing all of the legal requirements and ramifications, especially when a borrower is in or near bankruptcy. Bankruptcy can place the property in a receivership for months, if not years. "We currently own debt on two apartment complexes, and it could take us up to 18 months to gain title," Hill says.
Because the deals often have to close in 60 days or less, Hill and his partners hire third parties to handle market studies, environmental consultations, and construction assessments.
Focus on the Right Kind of Retail
Retail brokerage might not seem like a good place to find work right now, given the state of the market, but sales of well-located properties with national, financially stable tenants and triple-net leases are very active, says Peter Colvin, senior advisor with Sperry Van Ness Silveri Company in Grand Rapids, Mich. In a triple-net lease agreement, the tenant pays all real estate taxes, building insurance, and maintenance costs, making it less risky for the building owner.
About two years ago, Colvin made "a firm decision to stay ahead of the economy" and switched from industrial brokerage to "bite-sized" triple-net deals ranging from about $750,000 to $2 million. He specializes in leasing to value-oriented retail like Dollar General and Family Dollar.
In addition to working with builders to lease up new stores, Colvin drummed up listings through old-fashioned prospecting. He tracked down every dollar store in Michigan—more than 600—to find out if the building owner was interested in selling the retail space. His target buyers include individuals and small LLCs; with 25 percent to 35 percent equity, financing is usually available from local banks, Colvin says.
"We're seeing experienced investors who backed out two years ago when cap rates were 6.5 percent are returning now that cap rates are around 8 percent," says Ken Hedrick, a senior associate with Stan Johnson Co. in Tulsa, Okla.
Being an expert in retail requires a solid understanding of property values and what buyers or investors want. A favorable capitalization rate, or cap rate—the net operating income divided by purchase price—and a solid tenant may not be enough. "There's a new emphasis on other real estate fundamentals like location and market area demographics," Hedrick says.
Look Harder at Leases
If you have a knack for renegotiating rents and lease terms, your skills will be in high demand today. "In this economic environment, we're seeing larger tenants with good credit get some great deals," says Stephen Bay, executive vice president in the Los Angeles office of CB Richard Ellis.
When renegotiating leases for a large, multifloor tenant, it's best to start early—as many as four or five years before their lease is set to expire—and go out into the market to find "a believable deal" from another owner, Bay says. This shows landlords what they have to do to keep the tenant in place.
Smaller, more nimble tenants, on the other hand, might be better off waiting and watching to see if rents will fall even further, he suggests.
Representing landlords in rent renegotiations can also provide viable business, provided you can avoid the knee-jerk reaction of giving up anything to keep the tenant, says John Bemis, executive vice president of leasing and development for Jones Lang LaSalle, Retail, in Atlanta. "You have to review the P&L at the micro level and determine how that particular store is actually performing. If a store is profitable, we aren't going to automatically grant rent relief," he says.
If you represent the landlord, you can try to head off heavy rent reductions and concessions by taking a proactive approach; go into the market before tenants do and learn what deals are out there, says Greg Pavich, vice president of Coldwell Banker Commercial Utah in Salt Lake City. "Get the renewal at least a year before the lease expires, especially before tenants are approached by a broker wanting to represent them. You'll save the landlord money."
Both tenants and landlords will value your ability to audit leases for errors in space measurement, incorrect common area maintenance charges, and other factors that could affect the amount of rent payments, Miller says. "We recently found that a tenant in one of our properties wasn't paying for submetered utilities." she says. The catch netted the owner $65,000 in back charges and $5,000 in extra income.
Connect With Growing Tenants
Finally, don't overlook the fact that some companies are expanding even in a weak economy. Much has been written about the strength of medical tenants, but private colleges are also growing at a strong pace, Webb says. "A decade ago, there weren't any major private colleges in Florida; now there are 10," he says. These colleges often want office space near business districts.
In the retail arena, franchises—from fast food to tax practices—are growing, as laid-off workers opt for entrepreneurship, Bemis says. These deals do require extra due diligence on the part of a property manager; both the owner's and the franchisor's financial health should be scrutinized, as well as the business plan itself.
For Pavich, business owner-occupants, including a dentist buying a 2,000-square-foot office condo and a technology company opting for a 170,000-square-foot build-to-suit space, have proved to be valuable clients. "With construction costs down, it's a great opportunity," he says of his tech client's new space.
Another way to work with business tenants? As a consultant. Steve Price, CCIM, CRE, of REalytics LLC in Colorado Springs, Colo., assists companies in making buy-versus-build and rent-versus-buy analyses. "In an uncertain market, companies are willing to pay for good advice. However, you can't very well market yourself as a consultant until you've done some consulting," Price notes. To branch out in this area, "look at every assignment as a consultation," he says. Prepare detailed written reports of your findings when you solicit a listing or do a market analysis for a tenant. Then use those reports as a basis to get future consulting assignments.
No Magic Bullet
While it may seem painfully obvious, there's no real "secret" to prospering in tough times, says Richard Juge, CCIM, SIOR, president of RE/MAX Commercial in Metairie, La. "You've just got to work harder, smarter, and probably longer," says Juge, who's also the 2010 president of the CCIM Institute.
"The commercial real estate industry is changing, and those willing to change with it will always make a living, whatever the market," he says.
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You Can Be a Receiver
Many commercial real estate practitioners already have the skills they need to become a court-appointed receiver or provide property management services to a receiver, says J. Benjamin McGrew, CCIM, CPM, of Managewest Inc. in Carmichael, Calif.
A receiver is an unbiased third party that helps carry out a court's orders. With the increasing rate of foreclosures and bankruptcies in distressed markets, those who have the ability to help sort out these complicated real estate proceedings are needed.
McGrew, who's been acting as a receiver and federal bankruptcy trustee for 25 years, says receivers must have common business sense and know how to value a property. They also need to be able to maintain a property, keep it operating within a defined budget, and be alert for possible liabilities at the property. Leasing skills may also come into play.
There may be added challenges considering that many properties have a high vacancy rate and deferred maintenance.
The Court's the Boss
Unlike someone taking over a foreclosed property on behalf of a bank, a receiver is an officer of the court and must get approval from a judge for all major decisions. "You can't act without direction unless it's a question of safety or liability," McGrew says. "But this isn't always as onerous as it sounds, as many judges will approve a plan and operating budget and let you get on with the job."
Another tough part of receivership is its hurry up-and-wait rhythm. "You'll be called by a lender to provide a value on a property for an administrative default. Then, 14 or 16 months may go by before you hear about the property again," McGrew says. Things speed up again once you're appointed as a receiver; you usually have only a day or two to take physical possession of the property.
"You need to have your resources ready—a property manager and a good lawyer, as well as a title company to investigate liens and code violations," cautions McGrew.
Receivership assignments can last however long it takes for the borrower and lender to work out their differences, usually about a year. Oftentimes, the lender will end up taking ownership of the property and hire the company that acted as the receiver to manage the property until it's sold.
How to Get Started
Once you have the skills you need to handle the receivership duties, getting your foot in the door can be the hardest part. One way is to network with insolvency lawyers, who often suggest potential receivers to the lender or judge. You can track down lawyers' contact information by reviewing state court civil action records, which are usually available online. Each case also will include the name of the plaintiff-lender, which is another good contact for prospecting.
When you're new to receiverships, McGrew suggests that you first focus on nonjudicial, single-action bankruptcies. In these cases, the only asset is real estate, so you won't have to worry about valuing things like boats or art collections. Also, review the receivership order and make sure the court is giving you enough power and money to operate the property, says McGrew. "You should have enough money to at least keep the lights on and keep the property in order," he says. Also check your fee, usually paid at an hourly rate by the court.
Fees vary depending on training, experience, and the complexity of the assignment, he says. Entry-level receivers can expect about $125 to $150 per hour, while $275 to $325 per hour is normal for more experienced receivers.
The Institute of Real Estate Management offers more resources on receivership, including a webinar featuring McGrew. Visit www.iremfirst.org .
Mariwyn Evans is the commercial real estate editor for REALTOR® Magazine. You
can reach her at mevans @realtor.org
reprinted courtesy Realtor Magazine March 2010, original link www realtor.org/rmocommercial/Articles/2010/1003_commercial_newstreams
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