Bottom Feeders – and Bottom Feeder Funds – Our New BFF?
Bottom feeders have a distasteful reputation with some – but, truth be told, they are among the most reliable leading economic indicators of recovery for the commercial real estate industry.
There is a stunning disconnect between equity markets and the economy as a whole. The Dow Jones Industrial Average is at record highs, with 15,000 in plain sight. Equity investors are betting on a bright future. To gauge the economy by that measure, the economy appears to be healthy and rebounding nicely.
Leave Wall Street, and drive through urban and suburban retail districts, and the picture is not so bright. Vacant and boarded up storefronts are common. Parking lots are in disrepair. Shopping center signs are blank – or filled with half burnt-out signs displaying names of tenants past.
Sure. Commercial deal flow is beginning to pick up, but compared to what? A car travelling three miles per hour can triple its speed, but it is still moving at a remarkably slow pace by most standards.
I went for a drive recently, touring retail shopping centers and office parks to find out where the action is. The answer? Almost nowhere. It didn’t really surprise me. Although deal flow is picking up in my practice, most deals are with cash-rich bottom feeders (or bottom feeder funds) buying up distressed properties. Not that I’m knocking bottom feeders. Chances are good they will become some of the biggest winners as the commercial real estate market improves. Buy low – sell high. A time tested strategy.
One of the real challenges since the Lehman Brothers collapse in September 2008 has been the absence of bottom feeders. Deals have been hugely discounted, but there have been few takers. Why? Because no one with money believed we were at a reliable bottom of the market.
Things have changed. The bottom feeders are coming out in droves. This is an early sign of life for the commercial real estate market, but a danger sign for commercial real estate borrowers in distress.
One of the reason lenders have continued to amend and extend loans is because they don’t have much choice. Lenders don’t want these projects on their books. For the past several years, if lenders were to foreclose, or accept a deed in lieu of foreclosure, they were almost certain to be stuck with the property. There were virtually no buyers – at almost any price.
Lenders don’t need more REO. They don’t need the headaches. They don’t need the liability and expense of property ownership and management. What they need is to cash-out. Few investors, however, have been willing to bet the commercial real estate market was anywhere near the bottom, and fewer still were willing to bet the market was about to rebound, enabling them to make a profit on rising occupancy, rising rents, and rising property values.
At last, this has begun to change. A growing number of bottom feeders are entering the market – believing, apparently, the bottom has been hit and is about to turn upward. Are the bottom feeders right? I don’t know – but I do know that their numbers are growing, because the deals keep pouring through our doors. Cash deals, creation of bottom feeder funds, capital raises, and creative financing. At some point they may engender a self fulfilling prophecy.
This is good news for some – and bad news for others.
Why? You ask.
As deal flow increases, lender patience with underwater or marginal loans is bound to wane. If lenders can get out of their loans with an acceptable level of loss – out they will surely get. Most lenders are fatigued with distressed loans, and don’t want to risk another downturn.
Bottom feeders are increasingly giving lenders a viable way out. If you are a commercial real estate borrower living on short term extensions of your distressed loan, time is growing short. When that bottom-feeder, or other third party purchaser, comes along and offers to buy the loan or buy the property upon foreclosure at a price that will get the lender anywhere close to whole – or close to a level of loss the lender can afford to absorb, the next loan extension will be hard to come by, if it can be obtained at all.
Love them or hate them – bottom feeders are entering the market. By year’s end, we may find ourselves in a growing feeding frenzy. A word of advice: Position yourself accordingly.
Thanks for listening.