Can you spot a diamond in the rough?
the real estate collapse several years behind us, the industry has been riding
a wave of available distressed commercial properties. But this groundswell of
opportunity also brings a groundswell of risk. Knowing what to look for can
ensure that a bargain doesn’t become a burden.
some analysts believe we may have hit the peak, there are still good deals to
be had for savvy investors. Many lenders are still dealing with troubled loans,
and while some of them will be worked out with the borrowers, others will make
their way to the market.
key is to understand the intricacies involved in purchasing a distressed
property and do a proper investigation so you — or your clients — don’t end up
Complete Due Diligence
makes a distressed property attractive is also what makes it a risky
opportunity. A property priced below market value means it has issues —
delinquent taxes, possible liens, potential tenant issues, and more. You need
to identify all the property’s warts before
investing. Often the lender may not know or care to know those details, but the
buyer doesn’t have that luxury.
a property is distressed financially, there’s a good chance that the previous
owner has allowed it to fall into disrepair physically. A thorough inspection
from the foundation to the roof is imperative in order to understand the actual
cost to improve the facility.
you’re not familiar with the area, get on the ground and learn the market.
Looking at pictures and numbers won’t give you an accurate understanding of
what’s going on in the surrounding neighborhood. Identify the demographics and
the socioeconomic makeup of the property’s community. Some investors miss out on
opportunities to purchase distressed properties in smaller markets because they
view them as having less value. But this often is the home of the hidden gem.
find out if the area needs office, retail, or housing. If it is suffering from
an overcapacity of active medical offices, strip malls, or industrial parks,
then adding similar space with a depressed market value is going to be an
Use Local Expertise
estate always has been a local product in a local market. Many times
out-of-town investors zealously jump into deals with great expectations but
shortchange their reconnaissance of the local market. The result is they
overpay for a property, then they have to backtrack and bring in a local
service provider to make the property profitable or help develop an exit
avoid this trap, identify professional, experienced local service providers
upfront. They can help you avoid overpaying as well as identify potential
complications, including financial and structural problems — things you’re
never going to see in a picture or on a spreadsheet. Local market experts can
work to preserve and protect your investment while creating value and cash
are three ways to qualify your provider:
• Check for professional accreditations, such
as the CCIM designation.
• Ask the tough questions. Determine the firm’s
experience in that particular market, ask about their recent successes and
failures, find out how they measure results, and look for proof that they pay
attention to details.
• Talk to enough providers to understand the
market and average costs for services to avoid overpaying.
Determine the Price
as much art as science to determining the appropriate price for a distressed
property, especially when there are no recent comparable sales. A conventional
model for pricing distressed properties does not exist. It is important that
you clearly understand your costs to bring the property back into service and
factor that into your calculations when deciding what you are willing to pay.
Keep in mind your end goal is to charge the rent you ultimately need to be
profitable. If the seller is motivated to get out, you might be able to pay
even less for the property.
one case where Broder & Sachse recently stepped in, the lender got into a
protracted fight with the borrower over a 25-unit overleveraged property in a
solid apartment market. The property deteriorated and Broder & Sachse
became the receiver. Even though we stabilized the property, the lender wasn’t
willing to spend the necessary capital for improvements in order to lease the
units. Eventually, a local buyer bought the property for pennies on the dollar
and immediately began renovating it. The property now is at full occupancy.
what can happen when a buyer and lender don’t do their homework on the
property. The borrower paid too much and the lender lent too much. The next
buyer knew what he was getting — good bones in a good location at a bargain
price. He knew exactly what he could do with the property and what it would
cost to make it profitable.
with troubled or challenged properties is not for the faint of heart or passive
investors. Inexperienced investors can often overpay, and in the end, get hurt
when they can’t manage the investment. Distressed properties can provide
opportunities for new players to enter a market in substantial ways, but the
more you know about the property, the better. If you don’t have experience in
the arena, be sure to talk to someone who does.
Broder, CPM, is CEO of Broder & Sachse
Real Estate Services, a full-service company in Birmingham, Mich. Contact him