In general, distressed properties in the marketplace can be segmented into two distinct groups. First, there are those properties that continue to report relatively healthy operations but are simply incapable of generating sufficient cash flow to cover debt-service payments. Many of these properties were purchased or refinanced with conduit debt three to five years ago, when underwriting was most lax and often based on overly optimistic projections. Since troubles can be linked directly to leverage as opposed to property performance, many of these properties have become candidates for loan modifications, though some will ultimately hit the market, attracting a greater number of large, regional buyers to the metro area. In other cases, there are properties that were purchased by out-of-state investors, who, due to their lack of familiarity with local market nuances, experienced considerable reductions in NOIs through the downturn. These poorly performing properties have become targets for local buyers with cash in hand, since they offer significant turnaround potential for investors with strong market knowledge and management skills.

Apartment vacancies in Cleveland remain well below the national average and continue to fall short of the previous cyclical peak reached in 2003, but opportunities involving distressed properties continue to emerge. To date, the majority of distressed apartment deals have involved smaller properties, though lenders appear poised to increase offerings of large garden-style or mid-rise assets as foreclosures proceed through the court system, fundamentals begin to improve and pricing firms up. Within the CMBS sector, where local apartment delinquency recently surpassed 26%, more than half of the properties with outstanding debt consist of more than 75 units. More trouble likely lies ahead for larger properties in the metro area, since nearly 22% of the CMBS loans outstanding have fallen to debt-service coverage ratios of less than l.Ox. Many of the larger distress deals will crop up in and around the Euclid submarket, due simply to the above-average number of 100-plus-unit properties in the area, as opposed to deteriorating fundamentals. For smaller properties, the East Cleveland submarket, which posts above-average vacancy, will continue to offer the most troubled listings, however, private investors

may be able to find better-quality and higher-occupancy distressed opportunities in more stable parts of the metro area that have stronger tenant bases.

Retail accounts for the greatest share of distressed dollar volume in the Cleveland metro area, but the total receives a significant boost from a few major shopping centers. Many

of the larger troubled properties were financed with CMBS loans originated in 2006 and 2007, when values were at peak levels and high-leverage loans were common. Delinquency-rate trends reflect weakness in these vintages, while the overall60-plus-day delinquency rate for retail CMBS in the local market falls around 11.5%, the rates for 2006 and 2007 approach 15% to 17%. Maturing debt also poses its share of problems for local retail property owners, with a few assets recently transferred to special servicing due to difficulties refinancing in the current climate. In addition to tight credit markets and strict underwriting, reduced property values will continue to create their share of challenges as well, as many owners with maturing debt will remain reluctant to contribute significant equity to secure new loans. After peaking at $118 per square foot in 2008, the median sales price for Cleveland retail properties slipped 40% in 2009. While prices have edged up slightly, they remain significantly lower than just a few years ago.

Office properties comprise more than 20% of the distressed dollar volume in the Cleveland metro area, second only to retail, though REO sales remain limited. While most of the office-market distress has been concentrated in the suburbs, one of the largest troubled properties is located in the CBD. The 500,000-square foot KeyBank Center (formerly McDonald Investment Center) was transferred to REO status earlier this year via deed in lieu of foreclosure, after occupancy at the property plummeted. As of now, the lender appears focused on leasing vacant space before listing it for sale. This strategy may be employed by more lenders over the next several quarters. Lenders are also likely to wait for prices to firm up before selling large reclaimed properties. Even in the broader Cleveland office market, which includes stabilized assets, the median price per square foot has slipped more than 55% from the peak levels of 2007.

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