By Nicholas Minoia, Owner, Diversified Properties
Changing consumer behaviors and financial pressures resulting from the COVID-19 pandemic, coupled with an inevitable rise in interest rates, will soon trigger the release of a wave of distressed real estate assets that will hit commercial markets Across the country.
As this wave of struggling assets begins to skyrocket in the months and years to come, creative and experienced investors will be presented with rare opportunities to discover value across asset classes in some of the regions. the most competitive in the country.
However, as these properties often represent the most complicated and risky types of investments, it is important that investors fully understand not only how to identify and value distressed assets, but also how to create a strategy that will allow them to unlock. the value hidden in these unique properties.
Identify assets in distress
The complexity of modern real estate ownership means that stress can arise for a property at any time and in countless directions.
Family or joint venture properties can face partnership disputes or inheritance issues. A developer can suddenly face costly environmental issues, legal challenges, significant shortages in the supply chain, at prices
increases or problems with a contractor. A long-time landlord could suddenly run into financial hardship resulting from tenant departures, a changing pricing environment, or unpaid property taxes.
The factors that cause the degradation of properties are complex and multifaceted. More often than not, a property will have several, often aggravating, reasons that have earned it the nickname Distress.
For the owners of these assets, the label “distressed” leads to subsequent devaluation and other headaches down the road. While “opportunity” may be the last word that comes to mind for a distressed property owner, these properties offer creative real estate professionals unparalleled chances to find value in markets where traditional new construction or redevelopment can be difficult.
In hypercompetitive markets, the potential return can offset the increased risk that often accompanies investing in distressed assets.
Unfortunately, the myriad of ways these types of assets are degraded means that there is no simple, foolproof method to identify them. Also, since they are often off the market, finding a struggling asset is not as easy as combing through the properties on the ad services. Therefore, the formation and exploitation of relationships is essential to identify these assets.
Whether with brokers, lenders, city officials, or vendors, these relationships represent the surest way to find assets that are currently struggling, or on the verge of becoming so. While relationship building is the first step, it is also essential that investors build their expertise and understanding of how to execute a struggling real estate strategy with these contacts in order to stay at the forefront should an opportunity arise. .
Investors should have a concrete strategy to answer each of the following questions:
• Do you have the in-depth construction knowledge required to complete a half-built project?
• Do you have the legal team in place to resolve a complex estate issue or bankruptcy?
• Do you understand the real estate financing needed to resolve a complex capital issue, including negotiating with existing lenders?
Just as a developer would market their construction expertise from scratch, investors should constantly communicate their distressed asset capabilities to those who may be aware of these opportunities.
If an investor lacks direct experience with distressed assets, finding a more experienced partner can provide economies of scale and allow the investor to leverage the partner’s expertise in executing a strategy. ‘assets in difficulty.
Valuing assets in distress
Once an asset has been identified, its ultimate value must be determined. Valuation is another facet where struggling assets present challenges.
For example, while a modern industrial building fully leased to a tenant with a credit rating has an established market value, an older industrial building located above a contaminated site with a bankrupt tenant does not. . Use of the standard generic term “distressed” should not imply that all goods in difficulty are created equal. Again, experience and relationships provide valuable clarity during the assessment phase.
With an understanding of the construction process, financing, rights, environmental issues, and the nuances of local markets, investors can make informed decisions about the expected cost to bring a property out of its distress state and, thereafter. , what will be the ultimate value will be. This experience also provides insight into common pitfalls or concerns that a less experienced investor might overlook.
A lack of understanding of what to look for or how to value the different components of an asset can often lead an investor hoping to turn around a struggling property to simply become another owner of an underperforming property. .
Tangible issues – substandard, partially completed construction, rental issues, unresolved environmental issues – can cause headaches from day one. Less tangible concerns such as changing market dynamics or an unresponsive community that might be missed prior to an acquisition often lead to longer term issues in an asset’s life.
Even if an investor identifies a property and determines that it can be acquired for what appears to be a bargain price, if the value-added premium is only slightly greater than the troubled price, time, money and the energy spent on the property will not be worth it.
As investors strategize to transform assets, understanding property zoning, environmental condition, and other less fluid determinants of its future use should not be taken lightly. For example, if the strategy of a heavily contaminated former industrial site is to build multi-family units, investors must be prepared for massive outlays in remediation costs and a lengthy approval process.
In addition, each state’s eligibility process is very different. If an investor articulates their plan around a drastically different use of a property with variances and multiple planning board meetings, they might consider an expensive, multi-year process in a state like New Jersey versus a shorter, longer process. fluid. process in a state like Texas with a more flexible regulatory environment. The costs associated with zoning challenges, neighborhood opposition, and funding barriers alone can sink a project.
Likewise, a lack of understanding of the more fluid aspects – macroeconomic forces, construction costs, technology, consumer demands – of a project can be just as damaging to a struggling real estate strategy.
For example, if a plan for a struggling big box retail space is to simply find a new big box retail tenant, the profit outlook would be poor. However, if that same property is seen as a last mile distribution center for a large ecommerce company, the developer’s profit outlook rests on a solid understanding of the trends and forces driving the market.
While the profit opportunities for distressed assets are great, the challenges presented by these transactions can be daunting. However, through a strategic and prudent approach to the processes of identifying, valuing and executing a distressed asset, investors may find rare opportunities to create value in many of the world’s most competitive markets. country by bringing unique and sought-after properties to the market.
– Diversified Properties is a development, investment and management company focused on office, industrial and commercial buildings.