The most recent downturn in the real estate market is not a new phenomenon. Just like the economy, real estate has always been cyclical. There have been several instances in history where debt flooded the market and drove up real estate development cost and pricing overall. Aside from the current real estate crash we are pulling out of, many people remember the crash of the late eighties and early nineties – The “Savings and Loan (S&L) Crisis” or “RTC (Resolution Trust Corporation) Days” as it is known.
Not dissimilar to the current real estate downturn, the crash of the late eighties was caused by loose banking regulations and over-leverage. Our recovery out of the modern-day crash however, is different.
In 1989 the Government created the Resolution Trust Corporation (“RTC”) to liquidate primarily real estate related assets that had become insolvent as a result of the Savings and Loan (“S&L”) Crisis. The idea was to take over the bad loans, get them off the books, by selling at huge discounts to help clean up the cycle quicker. Astute investors who acted on this opportunity snatched up good assets at heavily discounted prices (sometimes at ten to thirty cents on the dollar). We have all heard or know someone who “made a killing” in the RTC days.
Just as riches were amassed by keen investors in the 80’s crash, the recession of 2008 brought similar opportunities to cash-laden investors and Real Estate Funds. As in every distressed situation, a great opportunity awaits. Investors and Funds licked their chops while stock-piling their cash. They are - “Keeping the powder dry” while waiting for “the other shoe to drop.” Just like these ever present clichés we waited for the banks and lenders “pretending and extending” to be over. Well, it’s been over for years now and the market is still eagerly waiting.
While there have been opportunities for investors to capitalize on the current downturn, it has not been as widespread and prevalent as expected. This time, the Government has been more calculated in the liquidation although not necessarily more efficient. The “pretend and extend” and “Quantitative Easing” has allowed banks and borrowers time for the economy to improve resulting in improved real estate fundamentals. The Fed’s stringent limits on Banks’ abilities to lend have curbed the widespread appetite and/or capacity for the market to develop and purchase new CRE assets. This has allowed more time for the over-supply to get absorbed before new inventory floods the market.
Now is the Time – “ALL OF OUR TIME IS NOT MEASURED EQUALLY”
The Pretend and Extend era’s demise is on the near horizon. According to the Mortgage Bankers Association, an estimated $800 Billion to $1.2 Trillion of the commercial real estate loans originated at the top of the market will be coming due in the next 5 years. It is predicted that more than one-third of these borrowers will be unable to pay off or refinance these loans. This fact will finally force Banks and Special Servicers holding these loans to liquidate and clean up their books.
As the economy hopefully improves, Banks are desirous to clean up their balance sheets, lend money again, and return to market fundamentals. These loans have already been written down and losses have been realized, thus improving overall financial stability. Most Banks simply do not have the resources, expertise, and wherewithal to service these non-performing loans in-house so they will either sell off the notes or turn them over to a 3rd Party Special Servicer. In addition to the lack of man-power, these lenders do not want the additional costs, time, and risks associated with possible bankruptcy, foreclosure, and ultimate disposition of these assets post-foreclosure.
Banks and Special Servicers can eliminate the risks above by selling these non-performing notes on the market. These opportunities can be fruitful for investors who know how to navigate through the complicated process. The buyer is buying an unpaid loan balance which is collateralized by an underlying asset. Buying a loan is much different than buying a typical CRE asset. In addition to underwriting the asset’s value, one must also closely review the loan documents, the borrower, and be familiar with all risks and processes of being a lender instead of an owner. There are specific lender liability laws and fundamentals to be aware of as a lender.
Multiple Exit Strategies – “YOU MAKE YOUR MONEY ON THE BUY”
If a buyer can purchase a loan at a low basis, as a percentage of value to the underlying real estate, they will be in a great position to explore multiple exit options. Buyer may then be able to:
1. Renegotiate the loan terms with the existing borrower
2. Negotiate a discounted payoff with the existing borrower
3. Foreclose on the borrower and ultimately own the asset at a below-market value
The most important aspect of these exit strategies is to understand the risks and costs associated with each option. A buyer must take into serious account these risks when generating an offer. Newcor has seen these loans trading at percentages reminicent of the RTC days.
Another very important consideration when considering a loan purchase is that the seller of a loan or note usually will require proof of liquidity and a track record. The note seller knows that buying a note is highly unlike buying real estate and prefers to not waste time and resources in dealing with unqualified buyers. Note sellers require significant non-refundable earnest money and a quick cash closing. Therefore, the bidder must closely examine the loan documents and underlying real estate.
Newcor is a champion of creatively disciplined investing and seizing exceptional CRE Opportunities. We possess the inside intelligence with the Banks and Lenders- and act with brilliant execution and performance. Our Firm utilizes the knowledge and experience of selling these loans for Lenders and representing Buyers in the acquisition of these non-performing loans. While there is great opportunity, there are also great risks if not executed correctly. We strongly encourage you to contact Newcor if you are interested in capitalizing on opportunities in the “Modern day RTC”.
About the Author - With more than 10 years experience in REO sales, Rob has transacted upwards of $100 million of REO/Distressed assets and notes on behalf of more than 22 banks and institutional lenders.