How Distress Investors Can Win in a Distress-Free Environment

Distress has frustrated investors in this latest round of disruption. Now Real Capital Analytics is offering a new way of looking at this conundrum and how distressed investors can win in this seemingly distress-free environment.

The answer, according to RCA, is through the repositioning of assets without good income prospects: preliminary data from the firm shows that 12% of distressed assets purchased so far this year were acquired with the intent to redevelop—double the amount of non-distressed sales set to be redeveloped over the same period. 

RCA analysts caution against relying on strategies from the Great Financial Crisis to weather the current storm, noting that the drivers of this downtown are “fundamentally different” from the last. During the last recession, distressed investing focused on investors stepping in to rebalance capital for cash-flowing assets that had too much debt relative to income. In fact, institutional capital accounted for 40% of US distressed purchases between 2010 and 2012, at the height of the GFC, and equity funds were behind a quarter of all distressed purchases during that time period. And in turn, those capital sources reaped big gains.

Conversely, this time around things are different. The pandemic “introduced a shock to demand that exposed underlying weakness, particularly in  retail and hotel assets,” according to RCA. Most property owners were well-capitalized before the pandemic—but the buyer pool for distressed assets is now changing fundamentally from the way things looked during the GFC.

“The elbow grease required to convert distressed assets to their highest and best use has drawn notice from a different investor pool,” RCA’s Alexis Maltin noted in a recent piece on the trend. “Between the second quarter of 2020 and first quarter of 2021, private buyers—predominantly developers, owners and operators—accounted for 64% of all distressed asset purchases. By contrast, equity funds were behind only 12% of distressed purchases, with the broader institutional capital category taking only 20%. Investors playing by the GFC-era rules for distressed investing may find current opportunities passing them by.”

Recent data from CoStar Group predicts a crop of distressed sales to hit mid-year. Modeling from CoStar suggests that the total amount of distress will land between $92 billion to $370 billion, though it will likely be $126 billion.

“It’s a pretty wide range,” Xiaojing Li, managing director at CoStar Group, told GlobeSt.Com in May. “We think it [the amount of distress] could be a blended scenario that is somewhere in the middle.”