NEW YORK CITY-Bruce Stern, principal of Red River Asset Management, has four rules that he believes any real estate transaction must follow: don’t lose money, don’t lose money, don’t lose money and make money. Since a fair number of deals at the market’s peak failed to adhere to those watchwords, there’s enough interest in distressed assets to drive multiple conferences and panel discussions, including the one in which Stern participated Tuesday.
What there hasn’t been thus far in the cycle is a plenitude of transactions. Some that have occurred, Stern said, have been driven by funds with money to burn that bought too early and paid “stupid prices” as a result. Jumping the gun on a distressed buy was one of the three general mistakes Stern discussed in his presentation, part of a seminar titled “What You Need to Know (But Nobody Will Tell You) About Buying Distressed Commercial Real Estate.”
Those other two basic errors: underwriting based on the past rather than current realities and not having multiple exit strategies. When it comes to underwriting, Stern advised, the smart investor will do his own and will examine all aspects of a property ranging from the rent roll to expenses. “Trust nothing,” he cautioned.
His fellow panelist, CEO David Tesler of Real Diligence, LLC, offered what he called a “positive” corollary to Stern’s “negative” warning: “Verify everything.” He noted that performing due diligence on a distressed property is vastly different from preparing to buy an asset under normal circumstances.
“It’s like opening a copy of War and Peace and discovering that the first 400 pages have been ripped out,” Tesler said. “You have a lot of catching up to do.”
Notwithstanding a few caveats, Tesler favors acquiring distressed assets through short sales rather than buying notes or purchasing bank-owned properties. Short sales offer the advantages of price, speed and more control over the borrower. By contrast, notes provide no guarantee of actually possessing the real estate, while both note and REO sales entail limited access to relevant documentation.
Tesler opened his presentation with an across-the-board maxim: “I can’t say this often enough—there is no typical deal.” Every asset is unique, every distressed buying situation is unique and the directives at a special servicing shop can change overnight.
Regardless of what form the acquisition takes, investing in distressed assets can be fraught with legal pitfalls. Gary Eisenberg, partner at Herrick Feinstein LLP, which hosted the seminar, provided detailed advice on how to steer clear of them.
While many of Eisenberg’s tips applied broadly—e.g., don’t ignore warning signs, do study the capital structure thoroughly and do understand who’s suing whom for what—he focused his discussion on note sales. “There is a wealth of areas you need to be concerned about when buying a note,” he said.
On the subject of “bad-boy guarantees,” intended to deter a borrower from filing for bankruptcy, Eisenberg said lenders have been on a “winning streak” in the past couple of years when it comes to the courts. “Do bad-boy guarantees work? The trend in the law is that guarantees of this sort will be enforced,” he said.
Eisenberg discussed the numerous scenarios that can arise when pursuing foreclosure against a borrower. One variable is the state in which the foreclosure action occurs. Some states, including Texas and Georgia, allow “power of sale” foreclosures which entail publishing and serving a notice and then conducting an auction. The process usually takes less than 60 days. In states that require judicial foreclosure, including New York, Florida and California, the timeframe can stretch out to well over a year.
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Paul Bubny
Paul Bubny is managing editor of Real Estate Forum and GlobeSt.com. He has been reporting on business since 1988 and on commercial real estate since 2007. He is based at ALM Real Estate Media Group's offices in New York City.
