Commercial real estate distress does not occur overnight. For properties and their owners, a distress scenario can play out over months or years, with the length of time influenced by factors including occupancy levels, the owner’s cash reserves and the forbearance of the lender.
What follows is a 10-step illustration of the stages of distress for a hypothetical office building, from the first stirrings of trouble to the property’s eventual reinvention as a performing asset under new ownership.
S T A G E S
Signs of Distress
Missed mortgage payments, declining occupancy rates, or legal disputes.
Example
Occupancy declines from 90% to 55% as major tenants relocate upon lease expirations. Deferred maintenance as the owner burns through cash reserves. A mortgage payment is missed, and then another.
1
Pre-NPL Phase
Negotiate for a resolution, such as loan modifications or refinancing.
Example
The owner attempts to negotiate with the lender but doesn’t have much of a bargaining position due to the loan terms.
2
Non-Performing Loan
When the borrower fails to meet contractual obligations.
Example
The loan goes past 90 days due.
3
Lenders Actions
Issuing notices of default, accelerating the loan, or pursuing foreclosure proceedings.
Example
The lender issues a notice of default and warns that foreclosure may be next, via a Notice of Intent.
4
Foreclosure
If no resolution is reached, the lender can initiate foreclosure proceedings.
Example
The owner and lender fail to reach an agreement. Foreclosure proceedings follow.
5
Auction
Timeline can vary depending on local laws and market conditions.
Example
A court-appointed receiver manages the auction. The timeline can vary depending on local laws and market conditions.
6
REO Phase
If the property does not sell at auction, it becomes real estate owned (REO) by the lender.
Example
The property fails to sell at auction, and becomes real estate owned (REO) by the lender, which hires a brokerage to market it
7
Resolution
When the asset is sold to a new owner or the borrower regains control through a loan modification or settlement.
Example
The asset is sold to a new owner, or the borrower regains control through recapitalization, giving up a majority ownership stake in exchange for continuing to operate the property.
8
Rehabilitation
If the new owner is an investor, they may rehabilitate the property.
Example
The new owner, or new majority owner, invests in a renovation and repositioning of the property to improve its competitive position
9
Return to Market
Property is ready to return to the market as a performing asset.
Example
The repositioned property is ready to return to the leasing market as a performing asset—possibly with a different use Ownership engages a brokerage to lease it up.
10
Be sure to read our three-part series: Distressed Asset Borrowers: To Sell or Not To Sell, Distressed Asset Buyer: To Buy Or Not To Buy and Cities Fight Back Against Downtown Distress.
