Inside the property logjam

It is no secret that bankers and real estate brokers are familiar bedfellows, working side by side on deal to pass property from one owner to another. But recently, thanks to a lengthening string of struggling housing developments, office complexes and retail centers, the worlds of real estate and finance are sheepishly eyeing one another across a disconnect.

As our economic troubles continue — Friday’s revised GDP numbers suggest we still have a ways to go — a large number of real estate properties are landing in the laps of banks. It’s a build-up of paper portfolios that has more than one financial institution nervous.

In a recent report, industry research firm Real Capital Analytics said the system is now dealing with $25.7 billion of “truly distressed assets,” commercial properties either in foreclosure, with a bankrupt owner or a defaulted mortgage. Banks have historically looked to turn such property quickly, and because of the well-known troubles in the financial sector, there is today an added pressure on institutions to sell off portfolios to generate badly needed cash.

In the past, a banker looking to unload a paper empire could usually look up to see vulture investors circling in the sky, today no one is pouncing on distressed property and the gulf between bankers, brokers and investors in growing by the day.

The reason behind the split, according to industry insiders, is a fundamental misunderstanding about value. With today's nose-diving market, no one has a clear hold on how much a property is worth.

“The bankers responsible for huge inventories are caught between a rock and a hard place,” said David Dreiling, managing director of Sperry Van Ness International's Asset Recovery Team. “They have portfolio loans and they're looking at how much they can get on the dollar for the loan. But actually, what they've got is a piece of real estate that needs to be managed, its rents collected, evaluated and eventually disposed of.”

But as banks set out to sell these properties, their portfolios of distressed assets are only predicted to grow. Loans scheduled to mature this year, coupled with continuing economic woes, could put another $80.9 billion worth of property in the hands of banks, according to the RCA analysis.

The Nashville area has its fair share of distressed and potentially troubled properties as well. According to the report, the Metro area currently has $171 million worth of distressed assets, with an additional $252 million potentially coming up in the next year.

Local brokers and bankers alike are positioning for an increase. First Horizon Executive Vice President and Chief Credit Officer Greg Olivier, his institution so far has been able to dispose of properties at the rate that it has taken possession of new ones.

“We don't expect that to continue,” Olivier said. “We'll see a build up at points prior to disposing, and we would expect that to increase somewhat into 2009.”

Brokerage firms, especially those affiliated with national companies, are mustering their resources to set up new special assets units.

“We're all anticipating that this is going to happen,” said Nate Greene, managing partner of NAI Nashville. “This is a time when [banks] are going to need third-party help to really figure out what they’ve got and figure out a strategy to liquidate it.”

All parties involved are carefully watching how the issue evolves. Right now, distressed assets are mainly residential properties in secondary markets and sprawl areas on the outskirts of major metropolitan areas. But in 2009, more centrally located residential properties are expected to begin heading toward the bank and there is a growing concern that the trend will soon spill into the retail and office sectors.

The price isn't right?

For banks, the value of a piece of real estate is tied to the original property appraisal and subsequent loan made to underwrite the development. But, Dreiling stresses, neither of these factors accurately reflect the current market value — so far as there is even a market value to speak of.

Because of the mercurial market, property appraisals as young as six months are not “worth the paper they're printed on,” Dreiling said. Real estate once valued at $10,000 an acre might find comparables in the same market dropped as far as $2,000 an acre.

“Because the market is absolutely flooded with properties, they just don't know what the real floor is,” he added. “The only comparable available today is the cash a buyer is willing to put on the table to take the asset off your hands.”

Even if banks make an additional appraisal at the time of their repossession, the sliding market still doesn't guarantee that the value will hold, and the original loan still hangs over the property. For banks juggling financial problems, taking 20 cents on the original dollar may not be an acceptable proposition.

The process of selling, however, is being complicated by the sheer number of properties falling into banks’ possession and the process many of them use to dispose of them. Dreiling said the responsibility for selling off these expanding inventories often lands on one or two special-asset managers with little to no knowledge of many of the specific assets or experience in the concerned markets. To shop properties, these bankers often send brokers bare-bones listings for hundreds of assets scattered around the country.

“I got an e-mail today with $120 million dollars worth of assets, 150 assets listed in order. But if you want to buy one of those assets, who do you call? One guy — and he can't answer any of your questions about the assets,” Dreiling said.

Already weighed down with the logistical burden of keeping track of vast and widely varied portfolios, special-asset managers also have to guard for possible swindles while at the same time facing pressure from above to sell.

“If I'm a banker, I'm terrified some stinker of a broker is going to stick a $400,000 offer in front of me, I'm going to sign it on a property worth $4 million, and I'm going to lose my job. At the same time, I'm terrified that if I don't sell these assets, I'm going to lose my job,” Dreiling said.

Finding a hard-to-find buyer

As the market stands today, those investors who do have capital aren't eager to jump into any sales. They know that banks are likely over time to become more desperate sellers as they become loaded down with more properties.

“The disposition side is difficult because there is an elevated level of problem assets in the banking system right now,” Olivier said. “There’s plenty of supply and there's a lot of cash out there, but the buyers for distressed debt are on the sidelines right now because they're not sure where the bottom is in the market.”

For both bankers looking to intelligently shed distressed assets and the brokers hoping to handle those sales, the solution is to start from square one and carefully reappraise. Prices for residential properties can no longer be set by comparable properties; area demographics must be analyzed to determine what price the local population can actually afford to pay in the current climate. Brokers familiar with each specific market must also be brought in.

National brokerage firms are beefing up their distressed-assets divisions. Dreiling's Asset Recovery Team specializes in engaging local agents to properly determine value. NAI Global recently introduced Commercial Property PowerSale, a service that offers live online property sales.

Or they might stay put, waiting for opportunities expected to materialize later this year in the retail and office sectors. In addition, the amount of government intervention in today’s economy has added a new level of regulatory risk to the mix. Many investors also are staying on the sidelines because they fear Washington will change the rules mid-game.

“No one wants to buy distressed assets and then have the government come in three weeks later and move the floor down another 10 cents, and then have overpaid,” Olivier said.