As part of the process when we assist lenders, attorneys and bankruptcy courts on assessing properties in default and about to be taken back – and whether we should attempt to restructure the debt, we need to take a more detailed look at the asset.
In many cases the origination underwriting and due diligence needs to be reviewed and revised considerably. We are no longer contemplating making a new loan (where the basic assumption is that we get paid back and never touch the asset) – we are contemplating directly owning the asset.
It shouldn’t just be the potential upside (“Sponsor isn’t performing, we can do better”), it should be (“What are the potential pitfalls of direct ownership and what are we about to be on the hook for that we didn’t realize?”)
I can detail many instances where the lender had to write off their entire outstanding investment simply by foreclosing and taking direct responsibility for the liability they inherited.
—Bert Haboucha
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Comments based on GlobeSt.com article: How to Be Prepared for Distressed Assets in 2024
Distress in the Commercial Real Estate Market
While optimism has returned to commercial real estate (CRE) in 2024, storm clouds still linger. Reduced property values, slower rent growth, and high interest rates are creating pressure on borrowers and lenders alike. A large wave of loan maturities is approaching, and many of these assets may struggle to refinance under today’s credit conditions. Lenders are working to avoid foreclosures, but special servicing and workout teams are preparing for an uptick in troubled loans. Since it has been years since the market has dealt with significant distress, many of these teams are being rebuilt and retrained on how to navigate the process.
The Expanding Scope of Due Diligence
When a loan shows signs of distress, lenders must dig deeper than during typical loan origination. Pre-foreclosure due diligence requires an equity-minded perspective since lenders may ultimately take ownership of the property. Modern due diligence now accounts for new factors that didn’t exist during the last downturn, such as stricter local ordinances, environmental regulations, and municipal safety requirements. Proper groundwork not only helps minimize loss but also prevents aggressive buyer renegotiations during resale.
Core Reports in the Distressed Asset Toolkit
A comprehensive due diligence package often includes valuation studies, environmental site assessments, property condition reviews, zoning reports, and ALTA surveys. Each tool sheds light on a different risk factor: whether the property’s use is sustainable, whether costly repairs or compliance issues are looming, or whether hidden liabilities could follow a foreclosure. Environmental reviews are particularly crucial, as updates to standards mean a once “clean” report may no longer be valid. Property condition assessments also play an essential role, especially where years of deferred maintenance or new local building ordinances could significantly affect value.
Construction Loans and Process Nuances
Troubled construction loans demand fast action. Lenders must quickly determine the project’s completion status, secure the site, and re-establish momentum—often with help from independent consultants. At every stage of pre-foreclosure, lenders face important timing and responsibility questions: When should reports be ordered? Who should commission them? And how can liability be avoided if problems are uncovered? The answers vary by situation, but one constant remains—thorough, timely due diligence is the best defense against loss and the surest path to informed decision-making in a shifting CRE market.
Read more on Globest.com
How to Be Prepared for Distressed Assets in 2024
by: Jenny Redlin, REPA | December 21, 2023 at 12:35 PM