A May 2020 New York Times article discussed the many commercial properties expected to become distressed two months into the pandemic. By December 2020, the real estate magazine The Real Deal reported that CoStar Group, which provides information, analytics, and marketing services, stated that $126 billion of distressed properties would sell. Some experts state that high inflation and interest rates will result in more opportunities to engage in opportunistic real estate, which includes distressed properties.
Opportunistic real estate involves purchasing properties that are in distress. Property usually falls into one of three categories before being considered distressed. First, the property may be run down, obsolete, or have maintenance problems, but the owners cannot afford to fix them. Second, the property may not produce enough monthly cash flow, forcing the owners to pay from their pockets. This situation makes caring for the property difficult. Furthermore, the owner may owe more for the property than it is worth. Third, the property owner may have personal financial issues, such as a divorce or lawsuit.
In 2021, many investment companies used the economic downturn to make money. At the time, more and more properties were becoming distressed, which created opportunities for investors, although risky ones. As a result, large investment companies amassed sizeable funds to buy distressed properties and their debts. According to a March 2021 article in the online magazine Chief Investment Officer, pension plans and institutions also invested in these ventures.
To lower their investment risks, investors should consider the condition of the properties. Because they are distressed, sellers want to eliminate and sell them “as is.” Furthermore, buyers may not know the extent of the damage or needed repairs until they buy the property. For example, a property may have environmental issues, like contamination, that the new owners must address.
Since the property is in disrepair, investors may face challenges getting a traditional loan. If they can find a lender, the terms may not be favorable. In addition, the loan may have a higher interest rate and more fees.
Outside of financing the purchase traditionally, investors may consider seller financing, in which the seller becomes the financing agent who lends money to the investor. In this scenario, the seller can give the borrower a first and second loan on the property.
The buyer can also enter a master lease agreement, taking out a loan over the seller’s existing mortgage. Using this method, the investor leases a building from the buyer and sublets the property to tenants.
The buyer can enter into a joint seller agreement with the owner. This agreement works best when the property needs many repairs or code violations, but the seller has no money to fix the problems. The buyer pays for the repairs and takes part ownership in the property.
Finally, investors must consider the renovation project itself. The building may require significant repairs. Executing the project may require assembling a team of contractors, subcontractors, engineers, lenders, and skilled laborers. This consideration is a priority because errors cause delays, which can increase the budget and lower returns.
