Distressed Asset Specialists See Deals In Reckoning That 'Dwarfs '08 Collapse'

Castles, gold mines, decommissioned missile silos and entire brands like Polaroid and Tommy Bahama’s. Hilco Real Estate Senior Vice President Steve Madura, whose firm specializes in distressed assets, has sold it all, but soon he expects an onslaught of a much more common type of property: CRE.

“The process is the process, and it works for any asset class,” Madura said. And increasingly, he sees this process put to work for commercial real estate. 

The next couple of years, when roughly $500B in commercial mortgage loans will require repayment or refinance, per the Mortgage Bankers Association, will “dwarf the 2008 financial collapse,” Madura said.

Refinancing with rising rates will lead to “a reckoning,” with borrowers in a “world of hurt,” and whereas the financial mess of 2008-2009 was caused by bad decisions around the financing of needed assets like single-family homes, the question about the long-term utilization of certain commercial real estate assets may lead to more trouble. 

Experts in distressed assets see this moment as an inflection point, and one likely to lead to high demand for their services throughout 2023. The combination of rising interest rates and a basically frozen capital market, coming after a period of low interest rates, has created what Madura calls a “distress bubble” that will impact CMBS, private lenders, private equity and eventually main street.

“Distress is becoming apparent much sooner in the process,” he said. 

Andy Graiser, co-president of A&G Real Estate Partners, a real estate specialist that, among other things helps renegotiate or terminate leases, or find subtenants, has tracked the same market slowdown. Obtaining financing and closing deals has become much harder, he said.

“Lenders are being a lot more aggressive with their borrowers,” Graiser said. “Before they worked with them a little bit more, because it wasn’t en vogue to foreclose. Now, because of all the financial stress that's out there, and Covid is in the rearview mirror, some of these lenders and some of these private institutions are getting a lot more aggressive, sharpening their elbows and forcing sales.”

Madura has been monitoring a spike in CRE-related bankruptcies since October that he expects to continue and make the second quarter of 2023 extremely busy for his firm. Many investors are holding on to dry powder, slowing down acquisitions because “they see distress, which equals opportunity.” 

Many distressed asset specialists have seen the demand for their services ramp up, and many are staffing up in anticipation of increased deal volume and opportunities. 

And they all think that office space that isn’t Class-A or a trophy building will suffer. Graiser said he “doesn’t see a floor yet,” in terms of where the office market will drop, and broadly speaking, believes this downturn will produce “permanent resets” in the way many sectors operate. 

“There are huge rows of office buildings in Chicago with 50% vacancy rates,” Madura said. “You want to convert so many office buildings to residential? That only goes so far.”

Distressed assets can refer to all manner of properties, but often come from two main categories; bankruptcy and distress, when an entire business is having financial trouble, or specific assets a firm wants to shed due to underperformance or other financial issues (perhaps they borrowed too much to acquire the specific asset and aren’t able to refinance). Hilco, which splits its business equally between those extremes, counts among its largest clients firms like Lowe’s and Starbucks that are far from financial distress. A&G finds itself involved with many firms that simply seek portfolio optimization.

There are as many different players in the market as there are reasons a firm may come across challenging times. Firms like Ten-X auction off distressed real estate, while Gordon Brothers liquidates industrial equipment and machinery. Hilco, which covers numerous sectors, hires specialists across different property types. There’s a hospitality practice within the firm, one that works on golf courses and resorts and one for industrial property.

Many owners exist in limbo right now, Madura said, waiting for the other shoe to drop. But he expects as more refinancing becomes necessary, owners will start looking for ways out. The firm predicts sectors hit by the pandemic such as leisure entertainment, as well as healthcare, like hospitals and surgery centers and senior living, will present opportunities next year, and Madura is gearing up for 60-80 hour weeks starting in Q2 of 2023. 

A&G’s Graiser said they’ve seen an upswing in business since the second half of 2021, with larger and larger firms finding themselves impacted by market conditions. That includes office space, which he predicts will face turmoil in the short and medium term because there’s just so much inventory that needs to be absorbed. 

There’s capital sitting on the sidelines, Graiser said, and some have suggested waiting out the distress to get better deals later in 2023. But it may not pay to wait; if there’s a good asset and the numbers work and you have the money, grab it, the demand is out there. 

Virgilio De La Piedra, founder of Oceanica Capital Partners, said there are assets out there trading at half their value from a few years ago. The tricky part to realizing the discount is often raising capital, which has become more challenging with higher interest rates, jittery investors and slower capital markets. 

“A lot of people are afraid of office, they believe that office is done,” he said. “Understandably, people are scared, but I think that if you find a good office deal in a good location and attractive terms … there's a bunch of smart managers out there that see the opportunities and would love to invest.”

Special servicers, who handle payments and communication for loans that have slipped into default, are seeing more and more properties fall under their purview. Firms that deal in distressed assets are also focused on staff that can assist with receivership, and holding onto and managing properties as they’re unwound from bankrupt owners and sold to new owners. Hilco may see a 15% growth in headcount in 2023, Madura predicted. Graiser believes their firm won’t expand, but the consultants they work with will see plenty of extra business. 

The need for more workers stems in large part from the industry’s tight time frames; Madura’s typical timeline to close a deal is 90 days. That’s one reason the sector has seen increased utilization of tech and software in recent years. Hilco uses different project management software to help organize the three-month sprints that typically unravel assets from old owners. 

And there’s also perhaps surprising investment in search engine optimization and social media. Madura said that most people don’t expect bankruptcy, or have the number of a specialist on hand, and a referral from a post, which an owner or lender may come across in a rush during an emergency, can be surprisingly lucrative. 

The nature of the industry can seem somewhat dark; in many cases it can be cast as finding a profit or upside in someone’s downfall. But Madura sees it as making the best of a bad situation. 

“We understand that this is not just dollars and cents, this is somebody's life and livelihood,” he said. “We take this very seriously and pride ourselves as being sensitive to the humanity of all this.”