Peter Pays Paul

The hotel industry is undergoing major stress. With incomes down and unemployment up, families are vacationing less. Fewer vacations means lower hotel revenues.

Many hotels were bought or sold during the height of the commercial real estate market. Take for instance the Casa Madrona Hotel in Sausalito, CA, which sold in 2005 for an estimated $20 million.

The San Francisco Business Times is reporting:

Sausalito’s Casa Madrona was sold at auction today for a reported $11.4 million — the estimated opening bid.

The article also mentions that this one hotel supplies almost half of Sausalito’s hotel tax revenue. It is no wonder why so many city and county municipalities are in trouble.

The San Francisco Business Times is reporting that More Lembi buildings sell.

Washington, D.C.-based Klingbeil Capital Management has paid about $10 million to acquire three San Francisco apartment buildings that were part of the Lembi Group’s rapidly disintegrating multi-family empire.

Page C1 of today’s Wall Street Journal is reporting that Blackstone Group, LP and CIM Group are attempting to acquire commercial real estate assets by buying the mortgages for a steep discount.

Private-equity firm CIM Group has teamed up with New York developer Harry Macklowe to help him regain control of what is regarded as one of the most valuable vacant lots in the world, according to people familiar with the matter.

This strategy is being used in a number of transactions. The success of this strategy depends upon the lenders willingness to take a loss on the property. Lenders that are in need of cash or understand that they are underwater on a property are more likely to take a discount.

In the case of the Drake Hotel site, a vacant piece of land doesn’t offer a lender much to work with. When Mr. Macklowe bought the lot it had a hotel on it which is more marketable. A lender is likely going to avoid a situation where they have to develop a piece of land.

The WSJ article also quotes Keith Barket from Angelo, Gordon & Co., a private-equity firm. Mr. Barket believes that the deleveraging of commercial real estate will take 3-5 years to complete.

It will be interesting to see if it does.

CoStar interviewed Hessam Nadji, managing director of research services for Marcus & Millichap Real Estate Investment Services, asking him his thoughts on the current recession.

Here are some of his thoughts on the length of the current recession:

We think job losses and the recession will end in 2009. We’re expecting that job losses will bottom by the third quarter, perhaps into the fourth quarter. For 2010, if you look historically, we’ve had plenty of instances where sharp declines and severe and sudden recessions have been followed by years of growth spike and better-than-average growth — especially the first year after a recession. But this time around, we still have a significant amount of consumer debt to unwind and we’re still dealing with a lot of headwinds in housing and corporate debt. I don’t think 2010 will bring an economic spike.

Nadji acknowledges that retail is going through some issues and may not recover until 2011 or 2012. He ascribes this to a problem of overbuilding in the retail sector.

On Distressed Property

We also need to know how much distressed inventory is going to appear and move through the market. I believe a lot of buyers with lots of cash are sitting on the sidelines looking for signs of an economic bottoming and waiting to see the scale of distressed property sales. Over the next six months, we’re going to get a better reading on the market because both financial institutions and owners of properties are still having stress and they’re going to have to decide what to do with those assets. I think there will be more motivation to sell at more realistic prices than there was a year ago.

…

One or two high-profile deals are not going to refine the market. Its going to take a little more volume, and a sampling of different asset sales in different places starting to trade, for it to become more of a widespread conviction that it’s time to get back in.

Using Cap Rates in Today’s Market

Nadji that cap rates are not as important as they once were in the realm of commercial real estate.

That’s not to say that no one thinks about cap rates anymore — they certainly use it as a metric — but you have to look at return on cash, number one, and using the new underwriting parameters to clear this market for financing, which requires more equity up front and much more realistic rent growth projections and occupancy projections. That would lead you to look at the return on investment for years year one through three in terms of cash flow, which is right now far more important than just a cap rate, which you can come up with in so many different ways.

RTC 2.0?

Nadji doesn’t believe that the current recession and distress in commercial real estate will lead to a second coming of the RTC.

Rather, the forces are working to minimize foreclosures, and therefore this notion of an RTC 2.0 that will bring quality assets to market at huge discounts may not materialize the same way.

He suggests that there are still quality deals available that have cash, can underwrite to today’s rent and occupancy rates, and are seeking to add value to their projects.

The LA Times is reporting that a Record number of California homeowners default on mortgages in 2nd quarter.

Year over year the actual number of homes being foreclosed on has increased 261%. The percent increase is dramatic. However the total number is only 63,061.

Based upon the U.S. Census Bureau Data California had 13,174,378 household units and 56.9% of those are owner-occupied. If these statistics are correct, there are 7,496,221 owner-occupied homes.

Though the increase is dramatic, the total number is still a small percentage of the total owner-occupied homes. This means that at most 0.84% of the owner-occupied homes are being foreclosed upon, or 8.4 out of 1,000.

However, my statistics do not breakout condos or home that were owned by speculators or investors. Many investors will stop making payments on their investment before they will stop making payments on their own home.

Likely, a lower percentage of owner-occupied homes are being foreclosed upon. A larger number are likely investor and speculator homes that were bought during the run-up in the real estate market.

Does the small increase from last quarter to this quarter signal that the damage is coming to an end? My crystal ball is broken. We will just have to batten down the hatches and ride out the storm.

This the third post in a series I am writing on finding distressed properties. Posts 1 & 2 can be found here.

Marketing

Marketing to owners of distressed property is the third method of finding distressed property.

Marketing Costs

For purposes of this post we will define marketing as the process of informing owners of distressed property, that you are interested in purchasing their property.

Almost all forms of marketing will have an out of pocket cost, before you see a return on the marketing investment. These costs may include printing, postage, design, or mass media expenses.

Marketing Budget

It is important to prepare a marketing budget prior to investment in any system. A budget will help you track marketing effectiveness and control spending.

Consistency is key to any marketing strategy. Most marketing takes time to show results. Dividing your marketing budget over months or weeks, will help to develop consistency and prevent you from “betting the ranch” in one marketing blast.

Market to Your Sphere

Each one of us has a sphere of influence that we touch on a regular basis. Our sphere includes friends, family, neighbors, clients, employees/employer, service providers, etc.

The easiest way of informing your sphere of influence that you are in the market for distressed property is through the use of business cards.

Business cards are an inexpensive way of informing others of who you are and what you want. By including a list of desired property characteristics on the back of the card, you remind the holder of what you are seeking.

Direct Mail

Direct mail consists of mailed advertisements to potential sellers. Direct mail is a proven marketing method, but has in general only a 2% response rate.

Printing and postage costs are both associated with direct mail. If first class postage is used, costs can be in excess of $0.50 per marketing piece. These costs add up very quickly and may limit the number of people you are able to reach.

Direct mail will have a greater efficiency if it can be targeted to individuals that have been pre-screened for relevant criteria. Criteria that may be helpful could include property owners, age of property, length of ownership, and building age. Title companies may be able to provide this information to you.

Signage

Bandit signs, fliers, and other types of signs can be used to garner the attention of would be sellers. This type of advertising is more likely to be utilized for residential properties than for commercial properties.

Fliers with your commercial property description could be distributed to local commercial brokers. This may be a way to inform the brokerage community of what you are searching for.

Classified Ads

The classified ads of your local newspaper may be a cost effective means of advertising your desire to buy distressed property.

Typically, those reading the classified section are in search of something specific. Classified users tend to be in the market.

A classified ad stressing that you buy real estate of all shapes and sizes may draw the attention of someone in need of selling or tired of dealing with tenants.

Mass Media

Mass media includes radio, television, and billboards. Though these methods have a broad reach, not everyone that sees or hears your advertisement will be a suitable customer. Thus, in general they are not a cost-effective means of advertising for distressed properties.

Conclusion

While there are many different marketing channels, you must find the method that works best for your property characteristics and fits within your budget. Once a channel begins to produce results, you should re-invest in that channel in order to produce even greater results.

Marketing takes time and requires consistency. Invest in marketing over the long haul in order to reap the rewards.

This is part two in the series on how to find distressed property.

Use a Professional

The second method of finding distressed property is to utilize the services of a professional real estate agent or agents.

Sidebar:
I have chosen not to use the term REALTOR®, because a professional real estate broker/agent may choose whether to pay for the use of the term REALTOR® or not. Many qualified broker/agents do not see the value in paying for the licensing agreement.
End sidebar.

A License, Does Not a Professional Make

Having a license to do something does not make you a professional.

I have a drivers license. However, that does not mean that I can get out on the track with professionals like Dale Earnhardt, Jr. or Kyle Busch of NASCAR.

During the extreme run up in home values many individuals saw an opportunity and pursued a real estate license. However, many of these same individuals only used the license for friends and family.

The newly minted licensees never committed enough time or education to support themselves fully through the marketing and sale of real estate.

Sidebar:
This scenario is more true in the residential market than the commercial market. However, it could be true of a residential agent that is transitioning to commercial real estate.
End sidebar.

Mark of a Professional

The term “professional” should only be applied to those agents that solely support their lifestyle from the marketing and sale of real estate.

Sidebar:
The professional’s lifestyle should not involve a rusted ‘85 Yugo or living in mom’s basement.
End sidebar.

A Professional’s Value

Market Knowledge

A skilled real estate professional is intimately acquainted with the target investment market. A professional should know what areas to avoid and which areas are ripe for investment.

Trained Eyes

Professional real estate agents have eyes trained to evaluate real estate assets. A professional agent will evaluate more property in a month than a layperson might in a year or more.

Agents and brokers, when trained to recognize what characteristics you are looking for, can provide quality leads. They are rewarded/paid only when they find a property you like and assist you in the purchase of that property.

Pocket Listings

Though “pocket listings” are frowned upon they can provide opportunity.

A pocket listing is a property that the broker has a signed contract to sell yet has not released to the general masses (MLS), but kept in their “pocket”.

Many brokers and agents have pocket listings that they release to a selected group of repeat buyers or investors that the broker knows will be interested in the property. Being on the short list of investors increases the likelihood that you will be able to find a distressed property to buy right.

The Network

Most professional brokers and agents have a network of individuals (escrow, mortgage, attorneys, finance professionals, other brokers, etc.) that can be put to work for the investor. Now the number of eyes and ears alert for an investor’s property type has just exponentially increased.

Downsides

The professional real estate brokers and agents that an investor wants to work with are busy people. An investor needs to prove to the agent that they are serious about investing and that the agent will be rewarded for bringing properties to the investor.

Brokers and agents need to be trained to find what types of properties meet your criteria. This can take a while and may also need some refining as they send you deals. Investors should follow up with brokers that send you deals. Let them know why a property is not right for your investment strategy.

Conclusion

While training a broker or agent what to look for may take time, it is definitely worth it in the end. Their trained eyes, experience, and network are well worth their compensation.

There are ways, even in a down market, to make money with distressed properties. The key to succeeding with distressed properties is to focus on “buying right“. Warren Buffett is quoted as saying, “Price is what you pay. Value is what you get.” Buying right is ensuring that that price you pay is congruent with the value you are receiving.

In any market, good or bad, there are those properties that are under-performing or distressed. Usually through physical repairs or through prudent management practices a poor performing property can increase in value.

The key to successfully investing in distressed properties is finding, controlling, and repositioning these assets. We will not deal here with controlling and repositioning distressed properties. The purpose of this article is to help you find them.

Distressed Does Not Equal Foreclosed

Foreclosures are the hot word in the media these days. However, distressed property does not mean that it has to be in foreclosure. Some websites that sell you information on foreclosed homes would like to have you think otherwise.

Divorce, death, illness, or absence can all lead to a properties disrepair and decrease in “apparent” value.

Pay Attention – Method #1

Have you ever driven the same route home and noticed a store for “the first time” that may had always been there? This seems to happen with new cars also. Once you buy a car you suddenly notice that everyone has the same model.

Your brain now aware of the specific model of car, can identify the characteristics that distinguish your model from all the others. The same is true for distressed properties. Once your brain is trained to look for them they will stand out in your mind.

Train your mind to recognize the signs of a distressed property. These signs will vary depending on if you are investing in multi-family, single-family, office, retail, or industrial properties. Each property type will have different tells that can tip the savvy investor off that the property is distressed and may be a good investment.

The Alphabet Game

On long car trips my parents taught us to play “The Alphabet Game”. The game is simple enough: each person tries to get through the alphabet sequentially by spotting letters on passing billboards or vehicles. The first person to spot a “Z” wins.

As kids “The Alphabet Game” taught us to be attentive to our surroundings and to notice what it was we were driving past. The same can be done for finding distressed properties.

It is very likely that on a regular basis you are driving past property that is in some sort of distress. It could be a house with absentee owners or an office building with a high vacancy rate. Unless you pay attention you would probably drive right past it and never know that it could be an opportunity.

Listen Up!

There are opportunities in the daily conversations around us as well. Listening for specific reasons that a property can become distressed (divorce, death, taxes, marriage, complaints about tenants or landlords, etc.) might tip you off to an investment opportunity. I would never advocate taking advantage of another’s misfortune. If you can genuinely help the current owner to a win-win solution, you are not taking advantage. Avoid becoming a carpetbagger.

Conclusion

Remember that distressed properties are not always in foreclosure. Most of the time distressed properties are easily noticeable if you know what to look for. Pay attention to your surroundings and to the events that are happening in people’s lives to locate distressed property.