Depending on what kind of distress they're looking for, investors in search of troubled properties in the Southwest are likely to find the most deals in the office and retail sectors and a high percentage of those deals in Arizona. That's the view from Phoenix, where Steven Lindley, executive vice president of the Capital Markets Group of Cassidy Turley/BRE Commercial, foresees a continuation of a trend that has developed in the Arizona markets.
The first and worst of the distress consisted of new developments in emerging suburban locations, Lindley explains. "Those hit the market quickly," he says. "Most have gone through the distress cycle and are now resolved or have been sold as REO or notes." The second wave of distress came in more centrally located properties that had previously been leased but are suffering from high vacancies, declining lease rates and high leverage. "That's where most of the opportunities are," and where many of the opportunities will be. Within those more centrally located geographic areas, office and retail properties will most likely offer the most opportunities, Lindley says, with relatively fewer deals in the industrial sector. "Here in Arizona and in other markets where our company works, industrial has been surprisingly limited because the owners are usually better capitalized and lower-leveraged," he says. "There is distress in all sectors, but there are probably five office assets for every one industrial that is distressed."
Lindley is quick to point out, however, that none of his observations about the geographic markets or distress-by-sector are hard-and-fast rules. Although he sees office and retail as the sectors offering the most opportunities and industrial the fewest, he notes that his investment sales group sold a 13% occupied, 220,000-square-foot multi-tenant industrial property in Mesa, AZ for less than $20 per square foot, a price that equates to the value of the land. "My sales pitch was, ‘Why don't you buy the land, and I'll give you a building for free,' " Lindley recalls.
His comments are borne out by the latest statistics on distress from New York City-based Real Capital Analytics, which reports a total of nearly $30 billion of distress in the Southwest, the third-highest total among the six regions covered. Within the region, Phoenix ranked highest with more than $9.1 billion of distress. Industrial assets, as Lindley suggests, account for the smallest bite of distress, about $1.4 billion. Office represents the largest chunk, more than $8.7 billion. Cushman & Wakefield, in its latest report on the Phoenix office market, noted that RCA identified 100 distressed office properties totaling $1.4 billion across Metropolitan Phoenix.
Not that other parts of the region or any property sectors have been spared distress, which has touched every geographic market and every product type throughout the US. In a recent deal in Houston, for example, Chicago-based Adams LaSalle Institutional Apartments acquired the 192-unit Stone Mist Apartments out of receivership from special servicer Midland Loan Services. And in the hotel market, which is recovering faster than most other sectors, significant distress is out there for investors with a hospitality bent: As this issue of DAI was going to press, Irvine, CA-based Auction.com was taking to market non-performing loans on 13 hotels in Houston, San Antonio, Dallas, Galveston and other locales as part of a larger, $200-million auction. And in a recently closed deal, Norwalk, CT-based HEI Hotels & Resorts bought the 309-room Sheraton Dallas North in a foreclosure sale, an acquisition that Russell Urban, HEI's senior vice president of acquisitions, described as a value-added play: "We have confidence in the market recovery and our ability to drive profitability through a comprehensive renovation." In another value added deal, as reported by GlobeSt.com, Dallas-based Stream Realty Partners in May acquired Plaza 35, a two-building, fl ex-space project, out of foreclosure. Stream already has a new tenant in part of the 185,485-square-foot property, which it bought when the project was 100% vacant, according to the GlobeSt.com report.
Other distressed assets in the region are being marketed for their value-add appeal as well. CB Richard Ellis is marketing a newly constructed retail center called Coldwater Springs Promenade in Avondale, AZ that first vice president Patrick Toomey and senior vice president Phil Voorhees in the company's Newport Beach, CA office describe as "a rare opportunity to purchase a bank-owned REO, anchored by Fresh & Easy and Staples with additional developable land." In addition to those anchors, the property offers the potential to lease up nearly 12,000 square feet and to develop nearly 90,000 square feet of additional retail and office buildings.
Some investors who bought distress during the first wave of troubled assets have already cashed in on the value-add proposition. For example, Lindley closed one deal in which the investor bought a note, foreclosed and then sold the distress three months later at a 25% profit. In two others, the investors sold the assets for profits as high as of 80% after a hold of nine months and a year, respectively.
"The owners on the longer-term holds did some improvements, but not much, just some minor cosmetic upgrades, and signed tenants to two or three leases," Lindley notes. "They realized such large profits because they bought them cheaply when fear dominated the market, and then they sold them at a time when the capital markets had improved somewhat." For more on hold vs. sell. click here.
About 80% of the buyers of distress in the Southwest are private investors, according to Lindley, who points out that roughly half of that 80% are buyers from California. Southern California buyers have fewer distressed assets to choose from in their own backyard because the coastal markets weren't as overbuilt as Arizona and Las Vegas, he explains. In addition, prices are higher in SoCal, as they were even before the era of distressed assets. A couple of first-quarter deals illustrate the California factor. In a receivership sale, the Bascom Group of Irvine acquired the Davis Building, a 20-story, mixed-use property in Downtown Dallas that includes 183 loft -style apartment units, 52,235 feet of retail space and a 600-space parking garage. In Phoenix, an Encino, based buyer named EC Garden Lakes LLC bought the 88,075-squarefoot Garden Lakes Centre retail asset from Evergreen Environmental Development Corp. of Spokane, WA, which acquired the property through foreclosure in November 2010. Mindy Korth, an EVP at CBRE and part of the team representing the seller, pointed out that, although the property was in distress for two years with no active leasing program to attract new tenants, it remained more than 80% leased. The occupancy reflects the center's location, which "will enable it to do well in the long-term."
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