Distressed debt is the obvious opportunity in commercial real estate these days, yet significant activity is frozen and most investors are not acquiring, but rather “just asset managing” their existing portfolios. Why is this? Most investors will dismiss the conversation with a catchy phrase such as, “the bid-ask is too wide.” Okay, so buyer and seller can’t agree on price, but why is this happening to begin with? Banks should be more than willing to work with opportunistic investors, shouldn’t they? Not exactly. First, banks know that if they sell off any distressed debt at a heavy discount, then the current accounting rules will require them to take a harsh write down on other similar assets, thus impairing their already stressed capital ratios. Banks have very little wiggle room.
To avoid having to face the music, banks will offer loan extensions to borrowers, in the hopes that employment, rents and occupancy will climb back before the new maturity date — “extend and pretend.” So, the banks are building a bridge to some far off destination, coinciding with a better day. The problem is that the bridge will have to be exceedingly long to get us out of the human recession, led by unemployment of 10%, and forecasts released today by the Obama Administration predict a reduction of only one percentage point for each of the next three years. So how do investors strike deals with banks, and which banks should they target?
A solid piece of advice is to negotiate with banks less on price and more on terms. One solution would be to create a JV between the investor and bank, then sell the note to the JV and structure the payout streams within the JV in favor of the “overpaying” investor, to make up for the loftier purchase price. The lender could also seller-finance the sale into the JV, further facilitating the transaction. Banks would avoid the sharp write-downs, and would more willing to work with investors, whose long-term interests are now aligned with those of the banks. Lastly, investors in this type of deal would be viewed as partners rather than as vultures.
So which banks are the best to target? By process of elimination, my answer would be the “somewhat stressed, but still holding on” banks. The healthier “too big to fail” banks have no reason to cut deals. The smaller “about to fail” banks are flirting with death and have no room to cut deals. Moreover, as many of these banks are one Friday away from being seized by the Feds, selling off assets would only take threaten the jobs of existing employees. Hanging onto distressed debt ensures a need to keep staff on payroll in the event of a seizure. That’s an agency problem if I’ve ever seen one.
That’s all I got for now…