Distressed property market at a tipping point

Distress is mounting in the CRE space as investment sales fall in Q2

Distressed property market at a tipping point

Evidence of distress in the commercial real estate realm is mounting. U.S. commercial real estate transaction activity plunged in the second quarter as the COVID-19 pandemic continues to cripple deal making. Real Capital Analytics (RCA) reports a 68% drop in transaction volume, the lowest level of a second quarter since the global financial crisis.

“There’s a lot of interest in distressed properties and loans and while they do exist, there's is still a real disconnect between buyers and sellers on what the price should be for those,” said Carol Faber, partner and co-chair distressed property practice at Akerman Law. “Owners still have a perception that their property is worth more, while opportunistic buyers are just looking for a great deal and aren’t inclined to buy anything until they feel the market has reached that point.”

Faber added that in many respects, it's still very much a wait and see. Despite a record number of loans going into special servicing and some lenders preparing to proceed with action, many are still trying to work with borrowers who have a possibility of overcoming the situation. As lenders begin to decipher which companies and borrowers have a better chance of making it out of the crisis, and which aren’t, that’s when more activity will kick off in the distressed market. Lenders in many jurisdictions are still not able to foreclose. Faber says when those restrictions end and lenders are able to enforce their rights, it will become more obvious which borrowers will be in a seriously distressed situation, which could result in a drop in pricing.

“We’re at a tipping point. There’s no way to quantify it yet, but there will be a lot of distressed loans and properties coming up. Certain industries will be more challenged, hospitality and retail mainly, and that's where there will probably be the most opportunities,” she said.

It’s clear the pain from the COVID-19 pandemic has not been experienced across all property types. RCA reported more than $30 billion in second quarter’s inflow of distress, with retail and hotel assets accounting for over 90% of that. Industrial represented less than 1% of all new distress, and Faber says student housing and office are still big question marks. The level of potentially distressed assets far outweighs that of outright distress and is distributed more evenly across property types. RCA says apartment assets accounted for more than 20% of potential distress in this quarter, while offices represented about 15%.

Growing opportunities

“The opportunities will not just be to buy distressed properties and restructure or buy a loan with an idea of potentially taking over the property if the loan is useful, but there will also be investment opportunities,” said Faber.

Borrowers who may need additional equity to survive may be looking to take in investors and partners, blowing the investing opportunities open much wider than just through buying real estate or loans.

“There will be a chance to invest into existing companies, where they won’t buy the company out, but rather invest, become partners and perhaps gain preferred equity.”

Faber adds that deals are still happening, but what is evident is that they are taking much longer to come to fruition, and there certainly aren’t as many. Certain sectors like industrial and multifamily are still doing well enough that lenders are willing to lend, buy and sell, and understand the value of those properties and how to underwrite those loans considering the uncertainty of the situation.