United States

Sourcing distressed deals

INSIGHT ARTICLE  | 

Key takeaways

  • Not all distressed assets are alike: Some may just need recapitalization, while others may need considerable expenditure to turn them into something new.
  • There could be immense competition for the best assets, leading to bidding wars and lower yields. Investors should be realistic in their underwriting and bidding to make sure they don’t overpay.
  • While many assets may be selling at deep discounts, investors need to consider their viability in terms of post-pandemic income.

Some distressed real estate assets may simply be overleveraged and need recapitalization. These deals could include perfectly healthy assets whose owners took on too much debt. With the immense amount of capital waiting to purchase distressed real estate assets, competition is likely to be fierce for on-market deals in this category, and investors should be careful that they are not overpaying and locking themselves into a low-yield investment.

But other opportunities may require heavier value-adds. While these deals are riskier, they present a chance for investors to remake entire assets, potentially driving higher yields.

“With the deals that just require recapitalization, firms can make their profits upfront just by working through complex restructuring and putting properties on more stable footing,” said Cross Lake Partners Managing Partner Jonathan Shumaker. “If on top of that you add some sort of repositioning to create value and manage the asset better, that is where you can find the really outsize returns.”

RSM US Partner and Real Estate Senior Analyst Laura Dietzel described how many funds are likely going to want to deploy capital into sectors like industrial, family or even land deals—all of which are asset classes that have not been overly damaged by the coronavirus pandemic. But with all the funds chasing the same deals, the highest bidder may not actually be deriving the same yield as a choosier investor who is able to find a value-add project in a lesser-known market.

Firms that were heavily invested in hard-hit asset classes like hospitality and retail may find it difficult to search for new deals when they are devoting so much of their workdays to time-consuming workouts with tenants and lenders at their own distressed properties. Shumaker suggested that these firms may be able to compartmentalize by having some of their asset managers focus exclusively on new deals.

Urgo Hotels Principal Kevin Urgo described how his fund is explicitly avoiding big-box hotels most of whose demand derives from group business, as he believes leisure travel and corporate travel will recover far more quickly than group travel and conventions.

Tipping point: If investors jump too early into a distressed asset, they may end up overpaying for a deal. Too late, and some of the most attractive investments may already have been snapped up.

Considering an investment in distressed real estate?

Explore key tipping points that middle market funds should consider:

Download E-Book