Commercial Real Estate in Distress? How to Win (Investors Round Table)
It's not difficult to find headlines around distressed properties and owners in commercial real estate these days. Private equity and hedge funds are raising capital left and right to scoop these properties out of potential foreclosure at incredible pricing. So, today, we're going to talk about distressed investment opportunities and how you can find these opportunities.
Brian Adams, Excelsior Capital
Dave Codrea, Greenleaf Property Management
Logan Freeman, FTW Investments
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Key Takeaways:
There will likely be distressed commercial real estate opportunities coming up, but it may not be as widespread or at "pennies on the dollar" prices as some headlines suggest due to the large amount of capital on the sidelines looking to invest.
Distressed opportunities will be very market-specific, with some markets like San Francisco facing more issues than growth markets like Dallas, Nashville, etc.
Finding distressed deals may involve working directly with banks on problematic assets they want to offload, or approaching distressed owners directly for off-market deals.
When evaluating distressed deals, it's important to underwrite the fundamentals of the specific property and market to identify upside potential.
About Your Host:
Tyler Cauble, Founder & President of The Cauble Group, is a commercial real estate broker and investor based in East Nashville. He’s the best selling author of Open for Business: The Insider’s Guide to Leasing Commercial Real Estate and has focused his career on serving commercial real estate investors.
Episode Transcript:
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0:25
Welcome back to the commercial real estate investor podcast live from Nashville, Tennessee. Because Oh, for some reason it is not starting on LinkedIn. We'll just continue without that. Live from Nashville, Tennessee. I'm here with Matt Anderson, a buddy of mine. You all may recognize him from a couple of episodes that we've done on the show before. Dave Co. Dre may not be able to make it. And I know Logan Freeman is tied up. So may just be us to today. Matt is looking at joining us on these bi monthly investor meetup. So Matt, I want you to just kind of give a brief introduction of yourself for those that may not be familiar with you, you and your story.
1:05
Yeah, man. Sure. Thanks. So yeah, basically, my background is as a lawyer doing construction and real estate litigation with our law firm Anderson legal but even before that, actually, I started investing. So started with single family homes and small multifamily and quickly figured out that commercial real estate's where I wanted to put my time and energy into. So it's been a story of, you know, law during the day real estate by night. And in recent years, it's become mostly commercial real estate focused rather than law practice. So
1:43
yeah, that's, that's the nice thing about commercial real estate, there's so many different ways for you to get into the industry. And you're doing something very similar to what I did, right, you have your day job, which is actually in the industry, where you get to kind of I mean, I don't know if you're doing this, but I live off the cash flow from that. And then I just take everything from all of my properties and reinvest that into more property. So it's a it's a phenomenal way to get started investing, if that's something that you're looking to do. But today, we're gonna be diving into distressed commercial real estate. Let me see if I can get my screenshare correct on here, it's looking a little funky right now. There we go. So, you know, distressed commercial real estate has been a headline for the past 12 months, really, everybody's talking about how much distressed commercial real estate is coming online. And I was listening to a podcast from Best Ever commercial real estate show earlier today, and they had a writer from a I can't remember which publication it was, but he was talking about how there's 117 billion with a B, dollars of Office loans coming due in 2024. And across the country, the average office space is sitting at a 20% vacancy rate. So you can imagine a lot of those loans are not going to be able to be refinanced, they're not going to be able to likely sell them at a price that they're going to want them at, which means that they're going to be in a distressed seller situation. So you may be able to scoop these properties up a pretty steep discount, and it's not just office could be retail, could be hotels, I mean, we could talk about any different asset classes, when it comes to this office just tends to be the one that is the hot topic right now considering what is going on in the world of office space. But, you know, I mean, going through this, I mean, the Lonestar funds, just raised $2 billion is an article from biz now raise $2 billion for its seventh opportunistic Real Estate Fund, according to the SEC, they have an equity target of $6 billion. And they're planning on leveraging it by about three times to get to about $18 billion of potential buying power. And they're looking at more distressed property types like retail, hotels, senior housing, anything that is going to be facing some issues coming up. Pretty interesting to think they're actually going to be buying this Distressed Real Estate from banks, they're not going to be buying it directly from the sellers, which to me means they're probably going to be getting really good deals on the assets. So what they'll do is they'll go in, they'll buy the loan off the books of the bank, the bank is already looking at these assets going, these are gonna be in trouble. We just want to cash out and move on. We don't want to have to foreclose on these assets. So we'll sell it to somebody else who's then going to service a dead Well, this opportunistic fund is basically going to come in and buy the debt. And as soon as the buyer default or the owner defaults, they'll foreclose on him. So Matt, you know, I know you've been tracking the real estate market quite a bit. I mean, what do you make of the distressed commercial real estate headlines? I mean, how much weight do you put into that? We've seen a lot of funds being raised to go and target that but are there any distressed commercial properties out there?
5:01
I mean, there are but you know, is it going to be this huge wave of volume and in you know, buy things pennies on the dollar? It's hard to know. I mean, it's hard to know, I would say the consensus when you talk to most operators is that we're going to see some deals, but we're not going to see this huge wave of opportunity, this huge crash, because there's, there's so much money on the sidelines, and the banks, they don't want to have to foreclose on these properties. And they don't want to take the properties back, right. So there's been a lot of extending going on a lot of pretending like everything's okay. And most of these banks are going to do that as long as they can get away with it. And as long as there's liquidity, and there's operators that can come in and work out good deals, like you're talking about with the banks, we, you know, I don't think that most of these numbers are going to end up in default, being foreclosed on, or being fired or sold. But you never know, there's a lot of a lot of stuff going on, that's never happened before, you know, with the interest rates. This is pretty unprecedented. With, you know, some of the some of the things that went on, we got some black swan events that could happen that could change this, but the consensus is if we stay on the track, more people think there's gonna be opportunities, but not just this huge wave of defaults. And I think it's also very market specific to its so market specific. Because if we're talking about, you know, class B, or affordable office space in Nashville, or we're talking about San Francisco, office space, it's it's a dramatically different conversation. So I think a lot of this pain is very location oriented, too, which is another thing that a lot of the news articles, skip over sometimes.
6:49
Yeah, I mean, that's, that's the thing that's been interesting to me following the headlines, because it's, you know, when you get into a situation like this, it's hyper localized, right? It's not like the entire economy is facing some sort of issue. It's very dependent upon specific tenants, specific buildings, specific markets. So will it be happening across the country? Sure. But it's certainly going to be happening in markets like San Francisco, far more often that it's going to be happening in markets like Dallas, Fort Worth, Nashville, Charlotte, Raleigh, some of these markets that are doing better anyway, because a lot of companies are relocating headquarters there. And you know, you can you can harbor whatever opinions you want about work from home, and how the future of Office is gonna be. But there are many companies out there that do not like a work from home model. It doesn't fit their business strategy. And they're going to work from office spaces. I mean, it doesn't matter if you're five employees or 500 employees, or just certain companies that want to do it that way. I mean, you know, I've got 14 employees, and we were from the office. I mean, you know, seven of those are brokers, right? So they kind of do whatever they want. But it's nice having an office space where we can get together. And it does, it's not a big one, right? I mean, for 14 employees, we occupy 1200 square feet, it's very small. So I can see that being the new normal moving forward as people have an office presence, but it might be a lot smaller than then, you know, what they had been focused on for a while. I mean, here's another article from the Urban Land, it's to the states that roughly $109 billion of capital raised for distressed funds is targeting opportunistic strategies. And when you account for globally, how much in funding has been raised for distress, that's over $200 billion. And the interesting thing here is they say this isn't the global financial crisis repeated or anything along those lines, the opportunistic capital that has been raised for both debt and equity investments does provide a good backstop for some of the distressed, some of the stressed and distressed real estate that does exist. I mean, that, to me, says, we might not actually see nearly the amount of distressed opportunities that are out there, because these funds are being raised unlike what we've ever seen before. And they're stepping in to distressed opportunities before they really get to the point of foreclosure or default, and saying, hey, I'll come in as mezzanine debt, you know, we're going to take this portion of equity equity, and we're going to charge you this interest rate. And, you know, we'll help you limp this deal along until something changes. I mean, that's largely why we haven't seen, you know, the crash, like we did, back in 2008 2009. There's a lot of, you know, powder on the on the sidelines, as everybody's been saying, and a lot of dry powder, and it's going into, I guess, different vehicles than what we're used to, you know, private money is coming in and basically becoming the bank in a lot of these situations. So banks don't have to bail out other banks or the government's don't have to bail out banks. Private money is actually coming in and bailing out banks, which is really interesting. I mean, Matt, what do you what do you make of that?
9:59
Yeah, it is really Interesting. And the other thing that's happening is there's a lot of operator swapping going on to you know, so some of it's not even really transactional, some of its, you know, you got to bail out that operator being replaced by a good operator, for example. So it is a very different situation. And I think like what you're saying the private money coming in and the fund money coming in, it almost signifies that the correction could, you know, could be limited. Because there is that backstop, right, it's kind of hard to imagine when all these funds are being raised, all this private money is coming in, all these operators are coming in to take these projects over, it's hard to imagine how it gets so bad in a short enough time to create some huge drop from where we are. And we've already seen such a tremendous drop in the market overall, right? I mean, across different asset classes, we've had huge corrections over the last year or so. So, I mean, we've got, I mean, I think we've got a consensus that the interest rates are not going to go up dramatically higher anytime soon. So we have this base case level that people can work off of now, where they come in, and they can underwrite it and replace the operator or replace the capital with private money. And nowhere their downside is limited to, in workout a deal with the bank, where the numbers pencil out. So something could happen, and there's definitely going to be opportunities without a doubt. But if you're in the majority of markets, I don't think we're gonna see some pennies on the dollar scooped up opportunities.
11:35
Yeah, it's funny, when I talk to people that are not in commercial real estate, they think that the sky is falling in investing. I mean, they're like, oh, man, you guys must be hurting right now. It must be so bad. I, you know, I'm reading the headlines. Everybody's defaulting. And when I talk to people that are in commercial real estate, everybody's like, Oh, it's great. Yeah, we're actually, you know, we're starting to make offers again, we're starting to buy properties. We didn't have any defaults. Now, granted, the majority of people that I'm talking to are relatively sophisticated investors. And they are very intelligent people. And, you know, could we be wrong? Sure. But we're not experiencing what the headlines are saying. Right? I mean, it really seems like it's these larger scale assets. You know, you're we're talking to the towers downtown that are solely office use, right? There's no mixed use component to it. It is strictly office. And that's really what struggling I mean, we're sitting in, well, I am Matt's not. But I'm sitting in my office building right now. It's a 28,000 square foot office building in East Nashville, three storeys, and it's 100% occupied. And it actually leased up more during the pandemic, I bought it in 2019, at 40%, occupancy is now at 100%. And it does just fine. Because we focus on smaller businesses that need that space. So it's, you know, I think it's kind of funny, just the the dichotomy between people that are actually in the industry and people that are just reading headlines, the differences of opinion of what's going on in the commercial world. But, Matt, I mean, like you said, there's gonna be lots of opportunities out there. And even in even in strong markets, there are distressed commercial real estate opportunities. You know, being an attorney, I know, You've been on that side, and you've seen quite a bit of, of, you know, workouts, right for investors that might be, you know, trying to get out of a bad situation or whatever. I mean, how do you typically come across distressed commercial opportunities? Where do you find them?
13:37
Well, and I haven't done as an investor, I haven't taken advantage of that a tremendous amount, I have been spending some time talking with banks over the last year or two. And I've noticed a trend where the extended pretend mode with the banks, where they really don't, they really don't, they don't want anybody to know how ugly their books are, or that they have this asset that really poorly. And they're kind of kicking the can down the road, they don't want to foreclose on it. And they're trying to work all these things out as long as they can. And so I think there's going to be continued continued opportunities there with these banks with with some of their poor assets where they don't have an operator in place that they can buy into that want to move it. I also think, I also think there could be you know, when you talk to these sophisticated investors like what you're talking about, you hear similar themes, but you know, some Mom and Pop operators who are just hearing the headlines may start to freak out a little bit may be concerned. And so I do think there could be some opportunity with off market direct to seller in the office space, for example, where you're buying affordable, low downside opportunities off market. I think this could stem some of that. But as far as, you know, higher end or on market deals being sold a steep discount? I don't know. We're I mean, we're gonna see an increase in defaults probably right loans are coming due, a lot of the loans from last year got extended into this year, which means there's more loans coming due this year than last year. So it's going to go up. But even if the defaults double, we're not talking about a ton of defaults, right? We're not talking about a ton of volume. So that's the thing. Yeah, there's gonna be more, and there's going to be opportunities, but I think most of it's going to be that workout. setup like you're discussing.
15:33
That's right. Yeah. I mean, if historic defaults are at two or 3%. And it doubles, we're still talking four to 6%. It's not. Yeah, it's a number like people think it will. Yeah, I mean, I don't see how it couldn't double. But it's funny, like when when headlines say things like that, oh, you know, defaults are doubling, people start to freak out, they think that's a big number, but you still think about it, okay, well, even if it's 6% to false 94% are still doing fine. Or even if it's 10, or 20% 80%, is still doing fine. Right? And that's the I actually really like as an investor, I appreciate what headlines start to do this, for the exact same reasons that you mentioned earlier, because I'm like, okay, cool, people are gonna start freaking out, I am going to focus on my fundamentals, I know exactly what I needed to do, what I need to buy a property at what I needed to do to fill it up. To make it make sense, let's go see how deep of a discount I can get on my opportunities. You know, if I can buy an office building today, that was, you know, even if it was another building like this, with its 40% occupied, if I could get it for 50 6070 bucks a foot, I'm taking that risk, because at the end of the day, on a price per square foot basis, if I wanted to get a 10% cap rate, I've got to lease it for $7, a square foot triple net, operating expenses on buildings vary city to city and building the building. But let's say it's five bucks a foot, six bucks a foot. I mean, you're still looking at $13 a square foot all in to make that make sense. Like, you'll find some small businesses that are willing to lease that space.
17:12
And the funny part is, is when you talk to investors, you know, what are they what are they looking for even the first article you brought up, you know, they're staying away from offices, which I thought that was interesting, you know, they're going after just distress, but they're staying away from offices. Which is ironic, because that's where the most distress is, right. But you don't I don't talk to a lot of investors who say I'm targeting office space, I'm going to buy X number of offices. And the next year, almost nobody I talked to is even talking about buying office, which is interesting. So I think they're I actually personally think there's some opportunity there, especially if you're capping your downside bubble, but buying below replacement cost and buying in areas where there's good supply demand, dynamics and good demographics. I just made an offer on an office building last weekend, but it's, you know, the offers a little over $100 a square foot, and that's affordable. And I think there's a lot of opportunities in those markets where I think the fear can become sort of national, where there's sort of like this national broad fear that goes around, that's not really targeted to any real reason. But then the real pain is more acute, right? Like the real pain is in San Francisco, and in New York. And in some of these places that were overbuilt and in the downtown areas. But some of the psychology is going to be more national. So I think that creates an opportunity. And in my mind, there doesn't seem to be a ton of competition of people looking for these.
18:41
I think you're absolutely right. I mean, we did a hotel acquisition coming right out of the pandemic. And Nashville has all of the fundamentals for an incredible hospitality market. Even during the pandemic. I mean, a lot of people were coming to Nashville, and we had all the data to show it. But every lender that I put that in front of was freaking out, they were like, No, hotels are getting crushed. Nobody's traveling. And I'm sitting here going, you're looking at national headlines. Here's the data of what's going on in Nashville, it's spiking, people are coming to Nashville, because they can drive here. It's a city that people want to spend some time and we ended up being able to pull that deal together. But it's the exact same for office space right now. I mean, if you can get out there and figure out how to put these deals together. You don't have any competition, it's your blue ocean. And you can get some really good deals. I mean, you can always refinance out of a bad loan, but you can't refinance out of a bad purchase price and I think that you can get a really good purchase price today. Let's let's pick apart that deal. Because I think it'd be really interesting for us to walk through you know why you decided to make an offer on an office building today because I'm in the same boat as you like I would make an offer on an office building today despite what everybody's saying, because I know the fundamentals of office space, but let's kind of walk through this exercise me what what was attractive about that property to you? Why did you decide to make an offer on it?
20:02
Yeah, and it's easy for me to say because it's the, it's the same as the last two office buildings I bought in the last few years. And for me, it's really simple my Buy Box, at least, which is I want to buy below replacement cost, I want to buy within, you know, 15 to 45 minutes, or really 15 to 30 minutes of downtown, preferably, I'm willing to go further, but I like to be close. But I want to be at that affordable rent. area, you know, in that category of affordable rent. So like if if downtown Nashville, rent per square foot, it's like $33, a square foot on average, or somewhere around there in the 30s, I want to be at or below 20s, right, I want to, I want to be out there marketing my spaces for rent at $18 a square foot or $21, a square foot, something like that. So for me, I feel like it's kind of hard to go wrong. When you're in that. And there's no supply, right? There's not, there's not a lot of supply there. And then even if there's a you know, even if there's a further problem with downtown office space, in my opinion, what a lot of those people are going to do is they're going to go a little bit farther out of debt out of town, or they're going to look for something a little bit more affordable. So that's my personal Buy Box, when I'm looking at offices right now, is I want to get below replacement costs, I want to be in the affordable rent ranges, and I want to be in decent areas close to downtown. So and then I want to be ideally I like to be direct to seller, because I really like to do deals with with seller financing. Because if I believe in the deal, then that's just going to juice up my returns on that deal. That's
21:40
right, and far less cash. That's a good point. Because right now a lot of those sellers are gonna have another option, right? You might be the only person that comes along, saying, Yeah, I'll buy your building, will you sell or finance a portion of it? They'll say, please just get me off the loan. Well, here's
21:55
the other thing, too, is it's like, okay, you want $2 million for your building? Right? Well, most people and I heard somebody do this today on a call, like, literally exactly, the suit was like, well, I'll probably have to put 25% down. So I'm gonna have to come up with $500,000 out of my pocket, and then they run what the returns are gonna be, ah, that returns not great. They move on to the next deal. It's like, well, I don't think that way, it's like, I'll give you $2 million, for sure. But we you know, you got to be able to do certain terms and, and carry a certain amount. You know, our last deal. Last two deals we bought, the seller carried the majority of one. So, you know, you give me good enough terms. I don't care what the price is. And I think there's going to be a lot of opportunity for seller financing. And we've already seen that for that reason. And there's an opportunity for investors because people don't look at deals that way. Most people don't. Right. So if they look at the deal, and they run their numbers on the price point, they'll move on. So that's how I approach it personally.
22:54
So on your capital stack, like how are you structuring that? I mean, equity aside? Are you getting the seller to seller finance? A majority of you said a majority of the loan. So does that mean you're bringing in a senior lender as well, and the sellers coming in a second position? Or kind of how are you setting that up?
23:14
Yeah, I usually do it two ways. One is that way. And that's what we did to those buildings on where the seller carried the vast majority. And then we brought the cash for the rest of it. So that's one way to do it. And I would prefer to do that every way easier. Yeah, yeah. I mean, we, one of the buildings, we literally bought for a million dollars, and only had to bring 25 grand in the seller just carry the rest of it. So like, I'll buy anything today. I didn't have to personally guarantee it either. So that's like, so like, I'll do limited amounts of those. But that's a little, you know, that's a little harder to find than the one we offer I just made, the seller would carry a portion of it. And then hopefully we can get the lender to be in first position. And then there'll be second position. So those are the two different ways.
24:05
But yeah, that's great. I mean, that's that's how you have to get creative with deals today to pull them together. I mean, we were looking at at acquiring a distressed mobile home community. This past week, which I ended up passing on for some interesting reasons. The seller decided that a pro forma was enough to disclose financials on the property. I was like, Dude, you you sat down and just typed this up like that's those aren't financials I need, I need access to your books and I need to see tax returns and he's like, yeah, that's it. I'm not I'm not providing you with anything else. All right, buddy. Good luck in selling your asset. But, you know, it's it's interesting to see just the the amount of capital that's out there that's willing to go into deals like this in terms of like structured debt, or if it's structured as you know, some sort of mez debt or even you know, equity position
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