March 1, 2010
By Victoria Burt


If it seems too good to be true, it probably is. At investment conferences last year, experts salivated at the prospect of a flood of distressed properties predicted to hit the market in 2010. Potential buyers are now finding, however, that all that glitters is not gold. Here are some myths about distressed properties and the realities of the market.

Myth: There’s a surplus of distressed properties on the market
“We’re not seeing a wave, we’re actually seeing the opposite,” said Patrick Deming, managing director with Eastdil Secured. “There’s more capital chasing fewer opportunities, which is resulting in more aggressive pricing than many expected.” Deming noted that the mentality now has changed and “everyone is just looking for a deal. They want to find an asset or opportunity to put money to work.”

Myth: Quality properties are available at bargains
Many buyers are looking for better-branded properties that are distressed. “But we’re not seeing a lot of availability in that category,” said David Mumford, senior principal at Mumford Company. “The better brands are outperforming their competitive set, and while business is down across the country, they’re getting a greater share of the business.” Owners and operators of these properties also are better prepared to handle difficult times, have deeper pockets and can carry properties longer.

Myth: A distressed seller will sell to the first prospect with an offer
Purchasers must be prepared to provide the seller/lender with information that supports their ability to close the transaction. This can include financial statements, résumés, letters from lenders indicating a commitment to lend on certain types of assets and documents that give the seller a greater confidence.

“One way to help distinguish yourself is the ability to offer a short due-diligence period, or a non-refundable earnest money deposit,” Mumford said. “If a buyer is willing to put up non-refundable $100,000, that speaks strongly to their commitment and confidence in their ability to complete the project.”

Myth: Buyers can negotiate one-on-one with seller/lenders
One thing buyers would like to get is unfettered direct negotiation with the seller of a distressed asset. However, “most lenders require a competitive bidding process,” Mumford said. “You’re not going to be able to slip in an offer on a one-to-one basis. Most sellers need to show in their files that they have exposed the property adequately to the market and received a number of competitive bids.”

Myth: Distressed properties only have financial problems
There are a lot of operational aspects to consider when going into a distressed situation. “Look at the physical property,” Deming said. “When a property is in distress, one of the first things they pull back on is spending money on anything that seems discretionary. Make sure the elevators, roof, etc., are appropriately addressed. If the property is branded, understand what the PIP requirements are going to be. And if you’re at risk of losing the flag, you need to evaluate that as part of your analysis.” Deming suggests making sure property taxes are current, and performing a sales tax audit to be sure transient occupancy taxes are up to date, too.

Myth: A distressed property can meet all of your investment wishes
“You might find a property that is priced well below its replacement cost, and from that perspective it will be a bargain,” Mumford said. “However, on a cap-rate basis, it may not have a lot of cash flow and thus it isn’t a bargain.” It’s going to be rare to find bargains that meet all of your investment parameters, he said. “Be prepared to compromise somewhere.”