Tuesday, March 24, 2009

The Fallacy of Distressed Asset Sales

Posted by: Scott Beggs
Investment Specialist
775 336 4644

Scott joined NAI Alliance in March 2008 to assist the company with investment sales. Previously, Beggs spent over seven years with Dermody Properties as Vice President of Acquisitions and Port Management.

There is not an article on commercial real estate that does not mention the widely held belief that there is a title-wave of distressed deals that will be coming to market soon. But the price of anything is determined through the interaction of supply and demand. And this interaction cannot be avoided.

First to address the supply of distressed investments. There is absolutely no doubt in my mind that opportunities will soon emerge as the state of real estate pricing becomes obvious to owners, lenders and investors. Despite the likely growth in supply of these “distressed opportunities” I can envision a scenario where this supply is somewhat muted compared to the dire predictions of many. Banks may begin to work with owners and re-cast debt terms rather than bring the assets on to their balance sheets. Owners with additional equity who correctly have a long term view of real estate will add equity to the game in order to extend loan terms. Other owners will get in front of the situation and accept loses through a managed sale process rather than waiting until the debt maturity date. So while there is no doubt that the supply of distressed assets on the market will increase, it may not be as dramatic as some are forecasting.

Now to the more interesting side of the equation – demand. Many intelligent real estate investors have been preparing for this upcoming wave of distressed assets for some time now by disposing of weaker assets in their portfolio, lining up potential joint partnerships, retiring debt and otherwise scrubbing their balance sheets and preserving cash. These investors are waiting expectantly for the distressed deals to emerge. These groups are well-capitalized, highly-experienced investment firms with defined strategies for how they plan to execute their investment programs. Somehow, many investors with an appetite to buy distressed have the misguided and myopic perception that they are the only active buyers out there. These groups somehow fail to accept that they will have to compete with others for these opportunities. If distressed assets are priced low enough to provide a buyer with significant profit potential, then the pool of potential investors for that asset grows dramatically. A seller may very well be willing to part with an asset (or forced to sell) at a price that provides significant upside for a buyer, but if there are oversized profits to be made, there will likely be a variety of qualified and interested buyers. The winning buyer will have to be beat out these other suitors for the property. The selected buyer will have to provide an identified discretionary capital source, a strong demonstrated track record of closing deals, solid references from past sellers, and a willingness to outline the timeframe under which a sale can be completed. And if other investors are better, faster, stronger, etc., then that group is going to WIN the deal.

So yes, good deals will likely emerge. But just because a seller is “distressed” does not mean that potential buyers will not have competition. The interaction of supply and demand still exists – and there is demand for these investment opportunities.

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