Is buying distressed assets the way of the future?

MB: Many buyers are still anticipating a torrent of distressed opportunities in 2010, but others have done well to change course and look for properties that are fundamentally sound from either a location or operational standpoint, rather than searching for steep discounts. The difference is really finding opportunity and not just expecting to pay a price that is a fraction of past values.

A good example of this is the sale of Easthills Apartments in Moore that CRRC handled in September 2009. Most buyers viewed this asset as being overpriced because it was offered for more than the previous owner paid for it in 2007, and it was generally considered that the previous owner had overpaid for the property.

However, the local buyer truly recognized the strong location and market demand and has significantly repositioned the 85-unit property.
This is a great case study of a value-add opportunity that most buyers won’t recognize because of their expectations for discounted pricing.  

What is “value-add”?

MB: By definition, “value-add” is where an asset can be purchased at a discount when it is underperforming for various reasons in an otherwise strong market. Most buyers, though, won’t recognize value-add, because they associate only price to the equation and overlook the asset qualities or location that create the value.  

What fundamental changes do you see in 2010 to the multifamily sector?

MB: A fundamental shift in 2010 is finding the decision maker on the selling side of the transaction. This has become somewhat elusive in 2010.
This is due to the complexity of distressed deals. Distressed opportunities require expertise beyond just a grasp of real estate fundamentals.

You now have to determine if you are working with a single seller or entity, or has that changed because of a default, pending default or receivership. If it’s the latter, you then have to look at all of the alternatives, whether it’s a foreclosure, restructure, workout, note sale or whether the property is going to auction.

These conditions have changed the way the brokerage industry operates.

The most straightforward thinking is that a property becomes an REO, and then the lender is willing to discount the price significantly for a sale. In reality, though, there are not many deals that are this straightforward. Buyers frequently discover that once they find these assets, they are unable to obtain the equity or financing to close them.

The complexity begins when a cash sale at a discounted price is not the most probable resolution. A special servicer, for instance, will employ the resolution method prescribed in the pooling and servicing agreement that established the CMBS (commercial mortgage-backed securities) trust.
The servicing standard within this agreement requires the special servicer to execute the strategy that gives bondholders the highest recovery on a net-present-value basis.

What we are finding today is that the recovery amount may be higher by restructuring the debt with a replacement borrower that is injecting new equity or capital to the deal. This may still involve a write-down of the principal balance of the loan, but to a much lesser degree.

These types of deals require a clear exit strategy for the special servicer. Barring an unexpected rebound in pricing, special servicers are not necessarily interested in just extending maturity dates, because that may only add to the next year’s troubles. Loan extensions only delay a decisive fix, and the special servicer wants to know how and when they will exit the deal.    

How is Oklahoma holding up in this changing environment?

MB: Oklahoma will fare much better then the rest of the country when it comes to maturing loans on multifamily properties where loan-to-value ratios exceed 100%. The weakness for Oklahoma City appears to be a CMBS market where loans were originated during a time when underwriting standards were slack. Many of these loans were underwritten based on projections that just didn’t materialize.    

What is a key point to recovery?

MB: Unemployment remains a key component of any sustained recovery in the multifamily sector. Oklahoma County, the state’s largest county, had a jobless rate in April of 6.1%, down from 6.4% in March, but up from 5.4 % in April 2009. Once a meaningful rebound in employment occurs, the positive long-term demographic trends should begin to kick in and greatly improve the operating environment for the apartment industry.

How is the market performing in terms of sales?

MB: Transaction volume has plummeted. For the first six months of 2010, there were 12 sales on properties that exceed 25 units in size, for a total of 976 units. This was a 44% decrease from the 1,739 units sold at midyear 2009.

Total sales volume was off significantly as well, down 68% at $15.8 million in 2010, as compared to $50.1 million for the first six months of 2009. The overall average price per unit on apartment communities with 25 units or more was $16,182, which is 44% below the $28,810 per unit average at midyear 2009.   

What is the outlook?

MB: Multifamily does well in both good times and bad, and the Oklahoma economy is one of the best in the nation, so I don’t expect to see a torrent of distressed properties in Oklahoma City in 2010. Investors who are patiently awaiting an ideal entry point into distressed multifamily may soon have to abandon that strategy.