Distressed Real Estate Assets Offer Challenges and Opportunities

As the economy continues to recover from recession, the nation’s residential and commercial real estate markets continue to struggle as foreclosure and vacancy rates climb. Lack of credit markets and precipitous declines in property values have also brought many new developments to a halt.

This overabundance of unsold real property in the marketplace presents an extraordinary challenge to developers and lenders – and traditional solutions do not always apply. But by working together, there are a number of opportunities available to help developers, lenders, and investor opportunity funds all better position themselves to emerge from the recovery in a strong financial position.

REO/NPA Marketplace Overview
Fueled by a record increase in foreclosures, the current recession has changed the Real Estate Owned (REO) and Nonperforming Assets (NPA) landscape as many financial institutions are unable to respond in a timely manner to the sheer number of foreclosed properties reverting to their books. According to RealtyTrac, more than 1.5 million foreclosed properties are expected to revert to banks as REO this year – exponentially more than the 160,000 that occur, on average, in a normal year.

REO and NPA balances continue to grow with a limited number of potential buyers. In this current environment, banks’ estimates of fair value of these properties reflect a longer term view of value and result in an ask price higher than buyers are willing to pay presently. However, banks often need to maintain their asking price in order to avoid realizing additional REO and loan losses and negatively affecting their overall capital. Attempts to sell the property can often result in additional costs to the bank from removing liens and other expenses.

Zombie Subdivisions and PVC Farms
Perhaps the starkest evidence of the scope of the current economic situation are the many abandoned development projects that currently dot America’s outlying suburban landscape. These half-started efforts – quickly dubbed by the media as “zombie subdivisions” and “PVC farms” – sometimes feature a few finished homes, but more often than not are comprised of little more than unfinished lots marked by overgrown weeds and exposed sewer laterals.

The banks that financed these incomplete projects face significant losses, as well as further complications since many of these abandoned developments were financed by more than one lender. Different banks often will have different approaches as to how they feel they should best dispose of REO and NPA.

As a result, many financial institutions now find themselves in an increasingly difficult position, burdened with an overwhelming load of distressed real estate loans and REO assets which they need to sell or settle. What course of action will result in the greatest return on disposition of the asset (or least loss) to the bank?

The Banker’s Perspective
Banks must make decisions from a risk management perspective as well as from a return on investment perspective, and their response to the current REO situation is no different. They also want to know how any proposed REO solutions will impact them with a number of entities, such as the Federal Deposit Insurance Corporation (FDIC), the Office of Thrift Supervision (OTS), and their auditors.

However, given the large scale of foreclosure growth over the last year, banks often do not have sufficient information about their REO properties needed to make well-informed decisions about the best course of action to dispose of them. If they offer them for sale, they may receive only low offering bids to acquire the properties as a result of poor due diligence information. Innovative solutions are needed to bridge the gap between the bid price and the asking price for these troubled assets.

Banking on Experience
Some banks are turning to advisors with local real estate market knowledge and experience to help identify solutions designed to maximize their return on REO and NPA assets while minimizing the negative impact on their financial statements. By working with real estate developers, operators, and investors, including opportunity funds, banks can benefit from an infusion of both the equity to invest and the in-depth real estate experience needed to maximize the return on REO and NPA assets.

Solutions can include new deal structuring, including joint ventures between banks, developers or operators, and real estate investors, debt refinancing with new equity and loan guarantors, and other creative alternatives. The right deal structure can often minimize further REO write-downs while letting banks share in any upside of future asset appreciation.

Developers have potential opportunities to partner with banks to complete abandoned development projects or unfinished properties. By establishing close relationships with banks, some developers may be able to position themselves to participate in opportunities with considerable “upside” potential.

At the same time, investor opportunity funds are forming to buy distressed properties from banks. They, too, are encountering a dearth of information about the properties available and their potential value. Properly evaluating these assets and acting to optimize their value will require these funds to also seek the advice of skilled professionals with the experience necessary to devise innovative solutions.

Distressed Asset Recovery Services (DARS) – How CB&H Can Help
CB&H’s Real Estate and Construction Group, in conjunction with its Financial Institutions Group, stands ready to provide a team of industry specialists who understand the extraordinary challenges and opportunities facing developers, lenders, and investors in today’s marketplace. We have the real estate, financial institution, transaction, accounting, and tax expertise needed to assist all parties in structuring mutually beneficial solutions, help obtain regulatory approval for favorable accounting treatment, and provide ongoing audit and tax services needed.

Through this fully integrated approach, CB&H’s Distressed Asset Recovery Services (DARS) team can deliver the industry-specific knowledge and experience necessary to bridge the gap between the “bid and ask” and to find solutions for both buyers and sellers of troubled assets. We can provide both sell-side and buy-side advisory services designed to:

1. help lenders minimize risk and maximize return in order to get back to the business of being lenders; and
2. help developers and investors find the right “deal structure” to work with lenders in purchasing troubled assets or in joint ventures to complete previously failed development efforts.

Our interdisciplinary team includes specialists throughout the Southeast who have extensive experience throughout all phases of the real estate lifecycle – including financing and development, strategic tax planning, and workout services. We also offer a depth of specialized resources through our affiliations with banking law experts, real estate advisors and lawyers, asset managers, investment banks, opportunity funds, and real estate developers.

Throughout our regional footprint, we have the local real estate market knowledge and expertise to help lenders, investors, and developers facing the challenges and opportunities presented by the current recession. From condominiums and resorts to office buildings and golf courses, we can assist in properly evaluating REO and NPA opportunities in order to help choose which workout option will result in the highest net realizable value for all parties involved.

Contact the specialists at CB&H, or visit us online at www.cbh.com/dars, to learn more about how our Distressed Asset Recovery Services can help you find the best solutions.