As Era of "Extend & Pretend" Ends, More CRE Shopping Begins

Posted on August 26, 2011

As the “extend and pretend” period of the Great Recession wanes into a period of true loan modifications, lenders and note holders appear to be forcing more distressed loans into the marketplace. And in turn, institutional investors, who were disappointed in the relatively slim pickings available in the distressed markets after raising enormous sums targeted for acquisition in 2009 and 2010, seem to be back on the hunt for more opportunities in investment-grade commercial real estate.

SilverLeaf Financial, a private equity firm specializing in buying distressed debt, this week acquired six non-performing notes secured by various apartment complexes in Georgia. The aggregate unpaid balance of the notes totals $16.6 million. Shane Baldwin, a principal of SilverLeaf, said depressed market conditions coupled with overleverage factored into the default.

“We liked the collateral, and felt comfortable with the location of the apartment complexes. Our investment platform incorporates a strategy in which we acquire loans and loan portfolios that are priced below the intrinsic value,” Baldwin said. “In the event we exhaust our work-out or restructuring options, the hope is we own the real estate at a very good value.”

Taking title to a distressed property figured extensively in another transaction this week, Global Fund Investments and MMG Equity Partners foreclosed on Harbour Village, a 112,886-square-foot shopping center in Jacksonville, FL, anchored by The Fresh Market and Stein Mart. After acquiring the conduit loan from a special servicer in an off-market transaction in April, the Global / MMG partnership set about the foreclosure process to take title to the property.

Gabriel Navarro, MMG principal, said, “We’re happy to have completed the foreclosure process and take title to one of the best-built and well located shopping centers in Jacksonville. This transaction is another example of our ability to move very quickly and work within nontraditional transaction guidelines and timeframes.”

According to the latest CoStar Commercial Repeat-Sale Indices, transaction activity increased 24% from 2,176 sale pairs in the first quarter of 2011 to 2,690 sale pairs in the second quarter of 2011. Investment grade transaction activity drove most of the increase. Noteworthy in the investment grade index is that the percent of distressed sales increased to 34% of the activity in June 2011 from 32.2% in May 2011.

In March, CoStar Group forecast $45 billion to $60 billion worth of distress transactions in 2011.

Bank “extend and pretend” strategies through 2008-2010 moved a glut of loan maturities to this year. As of year-end 2010, CoStar forecasted more than $850 billion in commercial real estate loan maturities this year. And 2011 has produced a strong stream of newly delinquent loans on top of already significant increases in loan modification and liquidation activity.

Under such “extend and pretend” policies, lenders and servicers simply extended maturity dates as a way to wait out the Great Recession. Then in the second half of last year, the number of “true” modifications of principal and interest rate reductions began to make up an increased share of activity. This also opened the doors for banks to start releasing loans they did not want to modify back into the marketplace.

As a result, the opportunities for investors to acquire properties through foreclosures on attractive terms has also increased, according to a white paper Urdang, the real estate arm for BNY Mellon Asset Management, released this week.

David Rabin, managing director, private real estate, at Urdang Capital Management, and the co-author of the report, said, “With banks increasingly willing to sell these properties and with commercial mortgage backed securities (CMBS) delinquencies at an all-time high, we believe there will be increasing opportunities to purchase or recapitalize over-leveraged assets at an attractive cost basis.”

“The ability to acquire these properties at attractive costs is possible because of the significant amount of commercial real estate debt that is scheduled to mature over the next four years,” said David Blum, managing director, portfolio management, at Urdang Capital and the other co-author of the report. “Many of these properties have experienced deferred capital expenditures, which will require owners to invest additional equity or dispose of their assets.”

Also contributing to the attractiveness of selectively acquiring commercial real estate is that, aside from a handful of high-end properties in top tier U.S. markets, commercial real estate values generally remain well below the pricing peaks reached during the 2005 to 2007 period, according to the authors. The report attributed this drag on commercial real estate to the downward pull exerted by sales of distressed properties.

“This drop in values has put many otherwise healthy properties in a position where they will require infusions of additional equity so maturing mortgages can be refinanced,” Blum said. “This gives new investors the opportunity to have a lower cost basis than those who bought similar properties a few years ago, providing them with the ability to offer lower rental rates than comparable properties with greater debt burdens.”