In The Distressed Asset Market, Extra Scrutiny And Creativity Are Making Or Breaking Deals

Once it became clear last year that the coronavirus pandemic was not going to fade away after a couple of weeks or months, investors began lining up money in anticipation of a wave of distressed commercial real estate assets coming online. As the pandemic has dragged on and lenders’ patience with forbearance increasingly wears thin, the hunt for distressed assets has already begun to heat up in some markets.

Despite the strong desire to get a deal on a discounted property, so far, would-be buyers are going over potential purchases with a far more critical eye than pre-pandemic, Newmark Senior Managing Director Laura Stumm said during Bisnow's Getting The Most Out Of A Distressed Market webinar on March 23.

“Investment-grade means nothing. Publicly traded means nothing,” Stumm said. “It’s really looking very carefully at the company and talking to the people on-site.”

Stumm, who is a lead member of the West Coast capital markets investment sales team and covers office and land sales, said overall, there is a much more stringent look at tenants — not just from a company perspective but also how they are using the space they have leased. 

“The big concern for office is, if you have a five-year lease, what’s the chance that at the end of five years, you will be at 100% capacity, Covid aside?” Stumm said.

Multifamily was another area where would-be investors are facing a few large unknowns, namely the growing amount of as-of-yet unpaid back rent — estimated at over $57B nationally as of January — and the protections provided to renters that prevent them from being evicted for nonpayment of rents due to the pandemic. 

“Understanding the credit of the tenant is a big part of [due] diligence,” RealtyMogul Chief Investment Officer Chris Fraley said.

RealtyMogul has investments in about 60 apartment complexes across the country, and of those, there are only “a handful” that are not meeting pro forma and those are usually situations where there is a credit issue with the tenants.

“Understanding delinquency and credit is a big part of multifamily acquisitions. In most of the [apartment] communities we’re involved in, there’s very little delinquency,” Fraley said.

Others were looking at a very different situation. Ocean West Capital Partners Principal Russ Allegrette said that on some units, tenants owe 12 or 14 months of back rent and there is not much confidence that rent will ever be collected. “The reality is, we think that whatever we collect will be a bonus,” Allegrette said. 

In instances where there is delinquency, Allegrette said creativity can be the thing that makes a deal work.

Allegrette shared an instance of an office building that Ocean West owned in the LA area that had a tenant who was significantly delinquent, went through a bankruptcy, “took advantage of just about every moratorium they could think of,” and remained in the space.

During the process of selling the building, they allowed the buyer to purchase the back rent at a discount. This poses a potential upside for the buyer if they are able to collect on that money. In the case of the building with the delinquent tenant,

“What ended up happening was, we sold the receivable [the back rent] for like 50 cents on the dollar,” Allegrette said. “I think that those kinds of solutions and the way you think about that as a buyer may differentiate you between other buyers in a market. If you can give value to something people aren’t looking toward as having much value, I think that’s a creative way to go forward.”