Executing the REO Deal

A multidisciplinary approach is the fastest road to profit and success.

By Joe Muratore, CCIM, and Ryan Swehla, CCIM

Distressed assets create tremendous opportunity for the savvy commercial real estate practitioner, but quickly capturing profit in this new arena requires a well-defined path to success.  Executing the sale of these assets is a multidisciplinary process involving brokerage, property management, escrow, and sometimes construction expertise.  Real estate pros should be well versed in procuring buyers, problem solving with banks and tenants, and stabilizing the asset.

Establishing Expectations

With real estate-owned assets, the lack of established market-rate pricing often creates confusion.  Typically the actual closing price will be near or below the former loan amount, so it is important to define expectations up front.

Is the bank realistic about the value of the property?  Is it focused on closing by the end of the year?  Does it want to hold out for the highest price possible?  Is it comfortable with a multistep pricing strategy?  What is its basis in the property and is it expecting to be able to recapture all of this?  Often there are few or no meaningful comps for a distressed property.

Building a candid relationship with a bank ensures that the real estate practitioner and the bank can appropriately respond to the market.  The broker and the bank should establish agreed-upon timelines and pricing thresholds.  It’s also important to understand the bank’s volume and required regional capacity .  Can you adequately service the bank’s capacity?  Should you partner with other brokers on other asset classes?  Generally banks divide their distressed asset portfolio by geography.  Be clear about the geographic regions in which you can perform.

Finding the Right Buyer

In an REO deal, buyers tend to be very demanding yet expect a rock bottom price.  This makes identifying the right buyer all the more critical for establishing the highest value and steps to close.

If the right buyer is an investor, it will be factoring in timeframes for lease up and likely will be using extremely conservative underwriting assumptions.  These buyers are more apt to agree to a swift close, but they often expect substantial price concessions in return.  Investors strongly believe that this is their market.  They will be fickle buyers and almost certainly will re-trade the deal during the process.  Investor buyers, however, are more plentiful and will aggressively pursue a property that is aggressively priced.

Owner-users, on the other hand, often are ideal buyers.  They have been sitting on the sidelines for months or years, watching the market and planning their expansion or relocation.  They recognize that now is the time to buy at significantly less than replacement cost so when they find a property that suits their needs, they’re often hesitant to let it go.  Owner-users also understand the constraints of the credit market and frequently have cash saved up and financing available for their acquisition.  However, these buyers are less flexible on product type and will quickly move to another site if a property does not meet their needs.

Rebuilding Relationships

Tenants and vendors have more experience with the property than you do.  If you are not careful, they will take advantage of you.

A building that has recently gone through the foreclosure process often will have hidden issues.  The bank, which may be out of state, probably will not know everything about that building – including tenant information and occupancy rate; how current the rents are; which leases are in full-force and effect; and which tenants may have vacated the building without proper notice.  It is highly likely that some tenants have paid rent in advance, or not paid in a while. Time should be devoted to establishing current rent and completing estoppels.

Additionally, because the previous owner was in distress, there are likely multiple vendor contracts and bills that have not been fully paid.  These can include phone systems, key card systems, alarm systems, and leased office equipment.  Investigate the status of utility service to the building to ensure bills are current and there is no risk of tenant or common area utilities being disconnected.

Clearing the Path to Close

Typically there are many obstacles to closing the sale of a building that was formerly owned in distress.  Taking the time to clear these obstacles up front can mean the difference between closing and not closing.

Title issues can be the most time-consuming aspect of preparing a property for sale.  Often title issues such as lis pendens legal notices and mechanics liens are challenging – but not impossible – to remove.  First make sure overdue property taxes are paid up.  Then check for reciprocal parking or access agreements which can significantly increase or decrease the value of a property.  Also, verify that remodels, repairs, and tenant improvements have been properly permitted and inspected.  Finally, check with local municipalities right away to determine what issues or fees are outstanding.

Many routine inspections, such as the five-year fire inspection or elevator inspection, may not have been completed.  This puts the property at risk of non- compliance or can invalidate occupancy permits.  Make sure these permits and routine inspections are current.

Close More Deals

In today’s market, if you’re not working in distressed assets, then you may not be in business at all.  To be successful with an REO deal, a real estate pro must know what sets these properties apart. Above all, more due diligence investigation and administration is required of the broker.  But if you make this a streamlined part of your process, you will close more deals this year and become a better real estate practitioner in any market.
 

Ryan Swehla, CCIM, is a principal at Sentinel Rock Realty Trust in Modesto, Calif.  Contact him at ryan@sentinelrocktrust.com.

Joe Muratore, CCIM, is a principal at Benchmark Commercial Real Estate Services in Modesto, Calif.  Contact him at  joe@benchmarkcres.com.