Where Are All of the Distressed Assets?

Our economy has been in recession for more than 18 months now and for the past year our real estate fundamentals have been adversly affected. Investors are constantly asking me to show them all of the distressed properties that we are handling for sale. The fact is that everyone is looking for these assets but there is really not much of this product presently on the market.  

A major reason why sales volume is down by as much as it is, is due to supply constraint as discretionary sellers feel that it is unwise to sell into this market. But, What about the sellers that have no choice but to sell? Many lenders fall into this category as the need for cash has left many of them seeking conversion of bad loans into capital. Stress has been evident in the market for quite a while so investors assume that distressed properties should be coming on the market to a significant degree. They have not yet and I will try to explain why this is the case.

As real estate fundamentals have eroded, defaults have been increasing and many lenders have had to put themselves in a position to deal with nonpayments. Many of these lenders have been very busy dealing with balance sheet issues, dealing with regulators and dealing with the government’s TARP initiatives. These issues, while very important, had “distracted”  lenders from addressing their defaulted loan issues.  

It has only been for the past few months that lenders have been figuring out what their exposures are and have been analyzing all of their troubled loans. Workout divisions within the banks have been staffed up and there have been significant enhancements to personnel infrastructure to deal with ever increasing piles of loan files that need attention. These “distressed” assets have been accumulating in a huge pipeline which is chock full of distressed properties and until now, these assets have only been trickling into the market.

We have brokered the sale of a few loans thus far in the cycle but are keenly aware of the potential supply which should reach the market in one fashion or another. Within the past 7 months we have provided lenders with valuations of several hundred nonperfoming loans and their corresponding underlying collateral. Our agents have identified several hundred additional properties which we believe are likely to go into default based upon the prices that were paid for them over the last few years and the amount of leverage that was placed on them. We are watching those asset very carefully.

Many funds have been established to purchased distressed assets, whether these assets are notes or properties,  and the funds have not been all that active due to the lack of supply that exists. These funds are patiently waiting for their opportunities and these opportunities will come.

We have seen distressed assets slowly coming onto the market in greater numbers and feel that the massive pipeline of these asssets will really start to open up during the third quarter of this year. We know that billions of dollars of these assets are in the pipeline and they will present a buying opportunity unlike anything we have seen since the early 1990s.

In addition to the funds that have been formed, we have seen a resurgence of high net worth individuals and the old line New York families that have not been as active as invesstors backed by institutional capital during the past several years. These were the same buyers who made fortunes buying properties during the early 90s. We have also seen a resurgence of foreign interest on an individual investor basis. These foreign high net worth investors are coming into the market in numbers not seen since the mid 1980s. We believe this is due to the perception that prices are low and good values can be obtained today.

Distressed assets exist because of prices that were too high and leverage that was too available in great abundance and real estate fundamentals have deteriorated.  These assets will consequently be a significant component of our marketplace for years to come as some of the distress will be caused by mortgage maturities which are spread over time. As these assets hit the market, investors will find opportunities and we will see market dynamics in which lenders and investors both end up winning. Lenders will be able to convert nonperforming assets to cash and investors will beef up their portfolios with great long term assets.

31 Responses to “Where Are All of the Distressed Assets?”

  1. 1 MB June 26, 2009 at 12:56 pm

    Great article. You’ve often talked about market segmentation, and I’m wondering if you think it comes into play here. I personally think that for a very specific asset type, specifically rent stabilized, sub 10 million dollar properties in Manhattan(and possibly Brooklyn), we’re not going to see the wave of distressed properties that everyone is waiting for. Underwriting for this type of property was not AS out of control as it was for other types. And to a large extent, the rent stabilization “play” has worked out for a lot of owners. People who bought these types of properties in the “go go” days have been able to bring rents to market and raise rent rolls to a point where they can hang on to their properties despite having paid high prices.

  2. 2 JWB June 28, 2009 at 11:13 am

    It would seem that “typical” sellers are going to be sidelined until these properties and those with good assumable financing with higher leverage are off the market.

  3. 3 rknakal June 28, 2009 at 12:57 pm

    Hi MB, Thanks for your post. You are absolutely correct that a disaggregation of the market is necessary to accurately look at this issue. We will not see much distress in rent regulated multifamily properties in the sub $20 million range as, even at the peak of frothiness in the marketplace, loan to value ratios remained about 75%-85% and value reductions have not exceeded equity. As I have stated in other posts, cap rates on these properties are only up about 83 basis points from their low point which results in value reductions of about 15%. We have sold many of these assets and the transaction structure normally consists of the buyer assuming the loan and making a paydown of the debt to a more reasonable loan to value ratio. Larger multis were often done with higher LTVs and loans were securitized making this type of workout more difficult if not impossible. With regard to retail and office properties, value has fallen to a much more severe degree which will result in more distress. Additionally, the development market has been pounded so it is not surprising that this is the segment where we are seeing the most distress at this point.

  4. 4 rknakal June 28, 2009 at 1:15 pm

    Hi JWB, thanks for your post. Typical sellers, who are motivated to sell in the short term, are putting properties on the market now in order to sell before the glut of distressed assets come to the market.

  5. 5 Barry Smith June 29, 2009 at 11:24 am

    Mr. Knakal, My company, LoanSaleCorp.com is a loan sale advisor that is focused on commercial real estate loans. What we are finding is in concert with your comments. I do feel that the ice is thawing somewhat, and expect the 4th quarter to be active. Once the banks figure out the the Government programs are not going to be appealing ( or not exist at all ), we should see more product available. Bid / ask spreads are still too wide, and we anticipate that many of the banks will hold this line because of the need to preserve capital. In any event , 2010 should be interesting!
    Barry Smith

  6. 6 rknakal June 29, 2009 at 11:58 am

    Hi Barry, thanks for your response. It does seem like things are thawing but that process has been SLOW. Things will open up and, as you say, 2010 should be very interesting. Best of luck to you in your endeavors.

  7. 7 Moosebump June 30, 2009 at 12:12 pm

    You mentioned that you thought multifamily cap rates were up 83bps. Where do you think the market is for good quality office buildings?

    You point out that there is a growing backlog of distressed assets that could start coming to market but at the same time there is a pool of ready buyers. I’m wondering if you have a guess as to where prices go in this scenario? Are there enough buyers ready to step in to stabilize the market or is it going to get ugly?

  8. 8 Rmg July 1, 2009 at 1:40 am

    Mr. Knakal,

    Isn’t the real problem the government? Because of TARP and the money being funneled into the “banks that cannot fail” those banks have less incentive to cooperate with the debtors thereby creating a false market value for those property assets? The money these banks get allows them hold onto the assets and thus grid locks the normal washing out effect that would have already been in process had there been no TARP money.

    All the TARP money has done is prolong the agony of the recession by giving us a slow bleeding of the price correction which has to take place.

    Unfortunately, 2010 may be worse than most are thinking as not only will the recovery have to absorb the RE inventory but the new carbon tax and health care initiatives should they be enacted.

    As more homeowners and commercial real estate investor become aware of government mandatory (carbon tax) retrofitting and upgrading of their property (s) before they can be sold, you will see a further decline in property values whether personal residence or commercial property and fewer transaction as homeowners and investors have less cash to do the upgrades.

    The decline in property value will be in addition to the normal valuation adjustments that typically happen after every real estate bubble.

    Just my $0.02


  9. 9 AS July 1, 2009 at 6:53 am

    What has been your experience with how realistic the pricing is from the banks? In my dealings with lenders (particularly some in the NYC metro area), they have been rather unrealistic in their pricing. My guess is a combination of self-delusion and also a bit of “hope and pray” for a quick recovery. If they truly wrote down the loans to the appropriate levels, they would be in a very precarious position as far as solvency and regulatory capital ratios. In the absense of pressure from their regulator, they just sit tight. Regulators seem to have a lot on their plates and the FDIC (which is supposed to be self-financed) does not have the funding to shut down many banks as they should be. Do you see a break in this cycle? I still have not seen it around here.

    The other thing I have come across is that banks, even when they are realistic about the value of the underlying collateral on a note, do not adequately factor in the required return for a 3rd party investor in a note. They try and price it like buying a note (with a potentially hostile borrower) is a near risk-free asset.

  10. 10 Larry Schnapf July 1, 2009 at 8:01 am

    We have clients focusing on assets being sold by FDIC associated with failed banks because the agency is dumping the loans at very distressed prices.

    While there is some thawing, the changes to the mark-to-market rules have disincentivized the banks from selling loans. So long as the banks do not have to reflect the true value of these loans, the floodgates will not open. If the borrower is making its debt service, the banks consider that a performing loan even though the property may be worth less than the debt. Until the banks are forced to recognize these losses, I dont see the market getting much past a thaw.


  11. 11 rknakal July 1, 2009 at 9:10 am

    Hi Moosebump, Thanks for your post. For retail and office properties we have seen cap rates increase 150 to 200 basis points which equates to about a 25% to 30% reduction in value. With regard to the growing number of distressed assets vs the significant pool of buyers, even with tremendous buying demand, it will not be enough to prop value up as most of the buying demand has yield expectation which is very conservative. It will, however, be interesting to see how this demand plays out.

  12. 12 rknakal July 1, 2009 at 9:16 am

    Hi RMG, thanks for your post. You are right on target. Government intervention tends to make things drag out and it certainly has created a disincentive for lenders to move assets as they continue to just kick the can down the street. Modiications to the mark-to-market accounting rules created a disincentive as has the carrot of TALF and PPIP. There are significant ramifications of these initiatives. Perhaps I will go into more detail on these dynamics in Friday’s installment.

  13. 13 rknakal July 1, 2009 at 9:28 am

    Hi Arjuna, thanks for your post. I agree with your observations as well. To date, there has been a disconnect between perceived value and real value creating inertia on behalf of most lenders. Those that are realistic on pricing are able to move assets quickly but getting to that realistic price can be challenging. Clearly, there is risk associated with a note sale and, while every situation is different, a discount has to be applied for the legal fees, carry and risks associated with the workout/foreclosure process. That being said, I am seeing lenders becoming more aware of these dynamics and I believe that as more data points are observed, a market discovery will begin to be more transparent.

  14. 14 rknakal July 1, 2009 at 9:35 am

    Hi Larry, Thanks for your post. You are right on with the mark-to-market impact on transaction flow. Many of the deals that are hanging on by a thread are only doing so because LIBOR remains so low. If LIBOR were to increase by 150 basis points, hundreds of properties would be underwater in terms of debt coverage. As inflation kicks in, rates will rise and we are likely to see this dynamic play out.

  15. 15 Carl Todd July 3, 2009 at 9:01 am

    Is it possible that many of these distressed building have filed for a Chapter 11 work-out and are now in or just entering the courts during and/or for this process and the unresolved will hit the market at a future date especially if more of their tenants continue to go under?

    Keep you eyes on US Jobs, NY Jobs, DC Jobs, etc.(and I don’t mean Steve Jobs (excuse the pun)but if you’re a high tech building investor/owner Apple’s new job creation is one also to watch))

  16. 16 Rodney Shoham July 8, 2009 at 11:53 am


    I’ve spoken to you a few times on different deals. These distressed assets are out there, but the brokers handling them most of the time do not want to share the information with other brokers. Otherwise you would see alot more, most of these deals are quiet deals. I was trained and raised on the COOPERATION PHILOSOPHY, which you rearely see in COMMERCIAL REAL ESTATE. I worked for Sperry Van Ness in West Los Angeles. The company greatly expanded on that philosophy of (cooperation). If I get any deals in your area, I will forward.

  17. 17 Steve Win July 9, 2009 at 1:07 am

    Where are all of the distressed assets?

    The answer is Las Vegas. Make a trip out to Las Vegas in the next 3-12 months and bring your check book. The banks can only hold their cards close for so long and I would bet the ranch that they are bluffing. The amount of toxic assets located in Paradise City will make the Yucca Mountain proposal look like a Platinum LEED certified project.

  18. 18 MBP July 9, 2009 at 2:08 pm

    Thanks for the summary

    How do you feel about construction loans? They are a different animal and require a buyer who can finish the project but it would seem that selling these notes for liquidity would be an avenue banks would entertain.

  19. 19 MPF July 10, 2009 at 8:42 am

    Hi Robert, I have been an interested reader of your writings for some time and have a question; don’t you feel that you as an appraiser of some of the very assets you may have been on the sell side and are now re-appraising for the lender need to take some responsibility as well? I’ve seen appraisals go from $100M to $30M in less than 9 months on properties and create upside loans that at one time may have had 30, 40 50% LTV’s and performing. The reality is the property was never realistically worth $100M, but perhaps 15% less would be more in line. The sale of the AIG’s buildings at 72 Wall and 70 Pine, which one can hardly say is a “market” deal, are being utilized as the litmus test for everything downtown. I find it a difficult comp to use effectively, yet due to a lack of any other sales comps to be found it becomes the de-facto poster child. I think a great deal has been made of how leverage and exuberance has lead to many of the defaults we are seeing, but the one of the causes lies at the feet of appraisers that, like their rating agency brethren, have swung the pendulum to the other side of arm just to cover hide and run. It would be naïve to place the blame at the feet of the appraisers but I think it’s worthwhile at least explaining that the “irrational” pricing disconnect as a result of their work has had a dramatic effect on the marketplace as well.

  20. 20 rknakal July 10, 2009 at 10:53 am

    Hi Carl, thanks for your post. Several owners are filing for Chapter 11 protection and the number is growing monthly. This is adding to the timeframe to complete a foreclosure process which is creating motivation for lenders to sell notes as opposed to going through an extended period to get title. With regard to jobs, I have been beating the drum of watching unemployment for over a year and it continues to climb, further weakening the fundamentals of our market.

  21. 21 rknakal July 10, 2009 at 11:54 am

    Hi MPF, I should clarify that I am an investment property sales broker and not an appraiser. That being said, a big part of my business consists of providing potential sellers with an opinion of value which is designed to be an indication of what the property will sell for, not its “value”. As a broker who also only represents sellers, I do not have to substantiate “value” to a potential buyer. When I am exclusively retained by the seller (the only way I will work) it is my job to maximize the exposure of the property to the marketplace, obtain as many offers as possible, and ultimately obtain the highest possible sales price for my seller. I am simply trying to make an inefficient market as efficient as possible.

    With regard to the culpability of appraisers, I think that is a tough argument to make. The appraiser’s job is very difficult. I have tremendous respect and admiration for the appraisal community and that is why my firm and I provide as much data as possible to them.

  22. 22 rknakal July 10, 2009 at 12:01 pm

    Hi MPB, Thanks for your post. Your question is a great one. Construction loans are the category where the most stress is being felt. These are the distressed assets coming to market first and will continue to dominate the distressed asset market until the income producing sector starts to feel the pain that the construction sector is feeling. Banks are increasingly looking to sell these loans as they do not, generally, have the expertise to complete construction projects. These notes provide good opportunities as the buyer pool is smaller than for income producing properties because to be a buyer you not only need capital but you need expertise. As there is a smaller arena of buyers, these opportunities tend to be better for the buyers that exist.

  23. 23 rknakal July 10, 2009 at 12:04 pm

    Hi Steve, I assume what you are saying is that you will “Win” if you buy distressed assets in Vegas. It will be interesting to see how the gaming industry deals with this prolonged recession.

  24. 24 rknakal July 10, 2009 at 12:19 pm

    Hi Rodney, thanks for your post, and your philosophy on co-brokering. It has been a company policy of Massey Knakal’s since its inception in 1988 to cooperate with other brokers on every sale we handle. Within two days of having our marketing materials approved by the seller, the listing is posted on masseyknakal.com and it is available for all co-brokers to work on. This is clearly in the seller’s best interest.

    I have never understood the sellers who want a quiet, off market deal. The usual reason is that the seller does not want “the whole world to know about my problems” if the property were openly put on the market. Well, the whole world may not know the seller’s problems but after the sale the whole world will know that the seller does not know what they are doing and surely left a tremendous amount of money on the table. Our average note sale today is producing about 50 offers. Most of the notes sold directly by lenders to customers of theirs are made after only a handfull of offers. Who do you think has a better chance of maximizing proceeds?

    Over the past 25 years I have enjoyed flipping properties for contract vendees who signed contracts with sellers who wanted a quiet, off market deal. There is no law that states you have to sell your property for the highest price but why wouldn’t you maximize your price?

  25. 25 srd July 21, 2009 at 1:43 pm

    Bob, Thank you for your post; I agree that the “pipeline” is full of distressed assets. However, I believe you have understated the obvious; the banks are doing everything they can to conduct workouts (even if the deals struck merely postpone the inevitable), avoid or defer property appraisals or property condition reports, and, in general, avoiding receipt of any “knowledge” of the current valuations of these assets. In summary, they do not need or want any more negative information for all the reasons you stated.

    Concurrently, the few folks in the market are having difficulty acquiring credit.

    When will the pipeline open up?

  26. 26 rknakal July 22, 2009 at 8:00 am

    Hi Srd, Thanks for your post. We are hopeful that the pipeline opens up later in this quarter or the beginning of 4Q09. You can feel the pressure building in the pipeline and it will burst at some point. The market could certainly use the product as there is very little for sale presently.

  27. 27 Larry Schnapf July 22, 2009 at 8:18 am

    i think we’re still in the “extend and pretend” mode. 🙂

  28. 28 rknakal July 22, 2009 at 8:26 am

    Hi Larry, at some point the ostrich has to take its head out of the sand. It’s not going to be pretty.

  29. 29 PvN - Normandy Group August 6, 2009 at 1:17 pm

    As a commercial appraiser in the NY metro area, I would like to respond to MPF’s comment about commercial appraisals.

    Although appraisal assignments can differ markedly from one job to another, those whose scope of work is to find a property’s market value usually have an effective date for which the specific value applies. While a good appraiser may believe that a particular market or property is overvalued, as happens in all market circumstances, or that values are trending in a certain direction, it is not their job to forecast future price movements. They are constrained by the existence of recent comparable sales relative to the effective date of their valuation estimate. Their value has to represent what a willing buyer would probably pay for the property given all of the circumstances of sale AT THAT TIME.

    For instance, a property in Battery Park City (adjacent to the World Trade Center) that was appraised for a particular value in August 2001, had a vastly different value six weeks later in late September 2001. However, in August 2001, the higher value was completely justified.

    An appraiser could note that based on historical trends, a particular value appears high, but the ultimate value has to be based upon factual data on prices as of the effective moment in time. Even if the appraiser’s opinion were ultimately borne out in the future, he would have no economic justification for deviating from a value that was adequately suggested by the comparable sales being considered.

  30. 30 Neil April 22, 2010 at 11:00 am

    Great article.
    I have one question, what size are these assets ($ amount)
    I along with my investors are relatively small, we have a small fund around 3 million.
    I am going to have an opportunity to purchase assets in this price range of 1 million or so, or are the distressed assets going to be way above me?
    Simply put are assets under 1 million going to be available or only assets for the “big boys” 10+ million range??

  1. 1 Twitted by flmfhren Trackback on June 26, 2009 at 7:17 pm

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