Best Practices in Distress Investing: No Single Strategy Prevails

When it Comes To Seizing Recessionary CRE Opportunities, Investors Don’t See a Specific Market or Property Type Holding a Special Advantage

September 15, 2010
When it comes to commercial real estate investment, distress is all the buzz. It’s the catchword that seems to always precede the word ‘asset’ and is currently the archetypical investment craze. There has been a downpour of money targeting distressed property, and according to CoStar Group data, almost one in every four commercial property
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sales done so far this year fits in some sort of distress category, whether it’s an REO or foreclosure sale, delinquent or underwater loan, or a property with negative cash flow.

CoStar sampled a number of commercial real estate executives asking them what strategies they found to be the best in pursuing distressed deals. In general, investors almost universally agree that a distress opportunity must have clear value and make sense for the buyer’s specific investment goal; the more uncertainty an opportunity presented, the less sense it made. Beyond that, there was only one consistent answer:

“There are as many strategies as there are investors,” said David W. Popp, senior vice president, Transwestern in Bethesda, MD. “Just as each investor may have their own distressed asset strategy, each property or portfolio must be considered independently on their own merits.”

“We don’t approach any given assignment with a preconceived bias in terms of quick flip, stabilize and hold, discount rate to achieve occupancy, etc,” Popp said. “Achieving the specific goals and objectives specified by our client is paramount and these may change based on the characteristics of the property, loan terms, strength of mortgagor, etc.”

Jeffrey Rogers, president and chief operating officer of Integra Realty Resources in New York concurred, saying no clear-cut strategy has emerged as the best practice. It all depends on what type of investor you are.

“The type of investor you are largely depends on the type of investment capital you have to deploy,” Rogers said. “For example, if you are running an investment fund raised with institutional money, which requires a certain return (typically in the double digits now) that needs to be achieved before the investor can share in the profits, you need to look for situations which offer adequate yields. In such a situation, the stronger markets like New York and Washington, DC, are not as attractive because of the relatively higher prices and lower yields.”

“If you are a REIT paying a dividend of 4%-6%, the stronger markets appeal to you because you can afford to focus on quality and take less risk in a secondary market,” Rogers continued. “The big REITs may earn a lower yield, but the return to investors is a lot lower. So, it really depends on where you get your investment capital and on your time horizon.”

There was no specific market or property or asset either that jumped out as having any particular advantage either.

“If investors want stability and a relatively safe investment, they would tend to prefer multifamily in 24-hour markets such as New York City,” Rogers said. “If the investors are willing to take on greater risk for a higher yield, they might prefer retail in this current market. The vacancy rate in retail is generally higher than the vacancy rate in multifamily in this market, but the upside is greater as well.”

Or an investor may not even prefer property, Rogers added.

“Properties acquired between 2003 and 2007 with significant leverage are underwater and no longer have equity. Thus, the target is the debt not the property. The goal is to buy the debt at discount. Depending upon your ultimate strategy, once you own the note, you can negotiate with the owner or you can move to foreclose to gain control of the property.”

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