In the ever-evolving landscape of the commercial real estate market, where fortunes rise and fall like tides, an astute investor knows that every storm cloud brings with it a silver lining. Amid economic uncertainty and market volatility, opportunities to capitalize on distressed assets in the commercial real estate sector are ripe for those with a discerning eye and a strategic vision.
Is Now a Good Time to Buy?
“All the economic indicators obviously point to a troubled horizon,” said David A. Nasatir, chairman of law firm Obermayer. The firm has launched a specialized law group for distressed commercial real estate. “So much is going on in the marketplace, so much upheaval in the marketplace. It screams to us that there are going to have to be some hard decisions in the future,” said Nasatir.
With a troubled horizon, restless investors are on the sidelines waiting to make a move.
“I would say the majority of buyers are holding back, but there are a handful stepping in and actually buying assets,” said Steve Pumper, executive managing partner of Transwestern’s Capital Markets and Asset Strategies Group with 39 years of CRE experience. He thinks the buying market is still in the early stage and expects things to really open up nine to 12 months from now.
“So ’24, ’25, ’26 will be the high watermark for CMBS loan maturities,” Pumper continued. “Right now, the lenders and the borrowers are working together to try and figure things out if they can.”
However, different from the last economic downturn, the market is floating with dry powder this round. “There are billions of dollars waiting for the deals,” said David Gottlieb, founder of GottsLaw, a law firm that specializes in commercial and residential real estate, as well as handling trusts and estate matters throughout Illinois.
Gottlieb was vice president, Asset Manager and Real Estate Disposition, at MB Financial Bank after the Global Financial Crisis. Ones with capital to deploy either buy or finance a deal with fees and proceeds as incentives, he stated.
“The overwhelming fear right now is that we’re nowhere near the bottom, that we’ve got a long way to go because of interest rates, because of turmoil, because of everything,” said Gottlieb. “I think we’re going to see a lot of modifications.”
How to Spot Opportunities
When it comes to identifying buying opportunities, an industry veteran like Pumper has his own system. “When I’m underwriting markets, I look at where the people want to live: municipalities that are pro-business and tax-sufficient,” said Pumper. He then analyzes the industries that he believes will be longer-term winners and where they are located. He likes to bet on a great labor force and pro-business environments with the right industries.
Spotting buying possibilities also requires vision to navigate and look beyond the market turmoil.
“Commercial office is the biggest risk right now because we’re going to have to repurpose all of these buildings,” said Nasatir. “And that relies upon a vision and zoning changes.”
“People are willing to deploy capital and make some bets in the office sector and some of the healthy markets,” said Pumper. He expects the capital loss in the office sector will exceed the last GFC. “It could be the greatest accumulation of wealth when people reset and buy office buildings going forward, which I think is premature at this point,” he said.
Gottlieb believes the office sector will come to an equilibrium once the employees and employers settle on a hybrid work schedule, “we are swinging from low interest rates to high interest rates at the moment.”
Factors to keep in mind
Purchasing distressed assets demands meticulous due diligence, according to lawyers who have been representing buyers since the last Great Recession.
“I would say that it’s more important now than ever to do your due diligence when you’re buying a note or real estate,” said Gottlieb. “You need to look at it from every different aspect to make sure that what you’re buying is what you think you want to own. Surprises cost you a lot of money and kill deals.”
Nasatir agrees on the importance of due diligence, along with a healthy dose of realism and good planning. “If you’re buying paper from a bank, you need to know how long it’s going to take to foreclose, to deploy, to take control of this asset,” said Nasatir. “If you’re buying from an owner, you need a plan for how long approvals are going to take place, how long you can carry debt service, how much equity you’re going to put into it.”
But there is a point at which a distressed asset just isn’t worth the investment, regardless of how low a price a buyer may be able to get it for. “The classic example is certain office buildings,” said Gottlieb. “People think that they can buy an office building and turn it into an apartment building, but there are about only 11% of all office buildings with the floor plates and the mechanicals all set up the right way to do it.”
In cases like that, owners or developers of aging office stock could get a break with the city offering tax abatements in exchange for updating their properties or converting them to affordable housing units.
That is what the City of Chicago is doing in the downtown area. Developers can apply for tax increment financing for office conversion projects that otherwise would not be economically viable.
The Big Apple is doing the same thing too. The New York City Economic Development Corporation and the New York City Industrial Development Agency have launched the Manhattan Commercial Revitalization Program (M-CORE) to provide financial assistance through tax incentives to renovate commercial office buildings in Manhattan.
The cycle of commercial real estate is a complex and ever-evolving process influenced by a myriad of economic, demographic, and market factors. To survive and thrive in the cycle, you need to be skilled at navigating these fluctuations and recognizing opportunities in different phases of the cycle.