A Guide To Buying And Selling Delinquent Office Space

The fate of the millions of square feet of office space sitting empty in downtowns across the country has the capacity to shift the landscape of the overall economy and commercial real estate. That outcome is increasingly falling into the hands of distressed asset specialists, whose job it is to facilitate the least painful result for troubled properties.

New York University professors estimate office property nationwide will lose a collective 49% of its value by 2029. Distressed sales of office space are likely, Colliers Research Director of U.S. Capital Markets Aaron Jodka told Bisnow in April, due to elevated vacancies and difficulty meeting debt service covenants. Specialists in distressed assets see “a reckoning” on the horizon. And buying, and financing, these assets won’t be easy, either.

“An investor I was talking to tells me he feels the banks are pulling out, they’re starting to view commercial real estate like crypto, that it’s very risky,” said Esther Reizes-Lowenbein, a New York-based equities connector and fund manager who started Esther Reizes & Co.

But this larger narrative will play out in thousands of smaller stories, building by building, asset by asset. As defaults look more certain, downward pressure on valuation leads to more sales, and funds to invest in distressed office assets begin to coalesce and seek buying opportunities, a wave of negotiations is just beginning.

“There’s a lot of interest, a lot of calls, but it hasn't really started yet,” said Mitch Vanneman, a vice president at Hilco with extensive experience as a receiver. “We’re not even in the batter’s box yet.”

The drama of a distressed property — determining if the financial relationship between a borrower and lender, displaced due to financial strain, can be repaired before a separation makes sense — tends to have three main players. The bank, which provides the loan, the borrower, which has taken out the loan to acquire the property, and a receiver, appointed by the bank to manage the property, and ideally, quickly stabilize, add value and sell it. 

In addition, workout lawyers who specialize in these types of transactions represent all the parties in play. Most come from a real estate finance background, often with loan production experience.

Before this plays out, borrowers become distressed and begin a dialogue with the lender. The borrower can decide to walk away from the property for many reasons: financial stress, bankruptcy or seeing more value in focusing money and assets elsewhere.

Depending on the depth of the distress and debt, and the state of the market, the lender can seek ways to provide some additional liquidity to the borrower, providing breathing room to get the asset back to a better place. In a nonrecourse situation — debt secured on the promise of default leading to asset seizure, but no other borrower assets — a borrower may simply hand back the keys. 

Lenders can decide, perhaps because they’re dealing with a borrower who is a bad operator, that they want to take back the property either via foreclosure or a deed in lieu of foreclosure. Lenders also tend to have a few extension options available on their loans, which is why many believe the worst of the current office slump is yet to come: Banks have kicked the can down the road as much as possible, often to add liquidity and free up cash to help existing borrowers attract tenants.

“If the landlord was a good operator, then there's really no benefit to move it until you at least had an opportunity to better the asset,” said Andy Graiser, founder of A&G Real Estate Partners, a distressed asset broker.

The receiver role can be akin to that of Mr. Wolf, the fixer from the film Pulp Fiction, Vanneman said. Success requires navigating extensive twists and turns, a focus on problem-solving and keeping a diverse array of stakeholders happy. Something as seemingly simple as a minor property upgrade before selling means figuring out licensing issues and getting everyone on board. 

“[It’s] a lot of tightrope walking,” he said. 

Their main tasks include hiring and overseeing property managers and leasing agents, and the potential sales process. Often, there’s a challenging calculus that needs to take place: invest more in the property to make it a better asset in the current market, or offer it at a discount. Part of that decision comes from checking cash flow, both short-term and long-term, and understanding how much time remains before key tenants’ leases mature.

After initial review, receivers will typically lay out a plan of action. They will explain to lenders what they may get for the asset in 90 days, six months and a year, and a list of potential capital investments that can be made. Then it is up to the lender to decide how to proceed. 

Lenders want to sell it as quickly as possible, recover the loan basis, and move on. Banks aren’t set up to hold or manage property long-term. Typically, receivers engage a third-party broker to sell the property, which gets marketed the same as any other office space on the market. The time frame for the process, typically six to 18 months, depends on the level of cooperation on the part of the borrower. Vanneman has had resolutions requiring more than 3.5 years. 

Situations where market shifts or downturns push borrowers to abandon their investments aren’t novel. What is new, and challenging, today is the pandemic-era drop in office demand due to remote and hybrid work, which makes the task of unloading office properties that much more difficult.

Lenders today can be more aggressive, seeing the somewhat sour future of certain office buildings, and seek a quick resolution to get the asset off their books. If they have reserves and can handle the losses from a quick sale, they might see a stock price bump by unloading office buildings.  

“They think suddenly that this is only going to get worse over time, therefore let's get out of this and lessen the losses by cutting our deal now,” Graiser said. 

It doesn’t always need to be contentious, especially when the borrower happens to have a large portfolio, and sees value in moving on and finding a resolution as quickly as possible.

On the other hand, smaller players, or those being difficult because they’re in particularly perilous financial situations, can play a delaying game, holding on to documents and playing cat-and-mouse with information and transparency. In that case, lenders can utilize what are called “bad boy carve outs” in the loan deals, and threaten borrowers with personal financial issues to force them to the table.

In addition, buyers looking to cash in and pick up great assets on the cheap will face extensive competition, Reizes-Lowenbein said. Numerous funds have formed to buy distressed property, so any asset at auction will attract a number of bids, driving up the price. And banks are locking up, with uncertainty and risk making it harder to get financing for deals. So even if prospective buyers can win an auction, or get access to a deal before the competition, they still need to cobble together capital. It’s a great time for those who can make all-cash offers. 

Long-term, one of the more challenging aspects of the distressed property space is how much may be coming. The current crisis is, “at best in the second inning,” Graiser said. With so many properties potentially at risk of receivership, there’s definitely going to be a run on talent. And, according to Vanneman, many in the workout space, especially the old guard, have retired in recent years. 

That will leave a large gap in experience that many attorneys and others will try to fill as stress boils up. It appears to be a great time to make that kind of career shift. 

“I just know that it's a very big bubble over the next two years as far as office debt goes,” Graiser said. “We’re still in a falling knife. The guys who got in early got burned.”

CORRECTION, MAY 31, 10:15 A.M. ET: A previous version of this story misattributed a quote to Esther Reizes-Lowenbein, when it was the sentiment of someone she had spoken with. The story has been updated.