If you think like an owner, you'll end up ahead
June 1, 2010
What's the best approach to non-performing real estate developments
or other real-estate-owned (REO)?
If you said "get it off the books quickly," join the crowd. The wrong crowd. Most lenders pursue a rapid sale to eliminate REO holding costs and recapture as much of the outstanding loan as possible. That sounds logical – but it overlooks five little-known secrets for increasing a non-performing development's value by millions of dollars.
What if your objective was to maximize the value of REO rather than quickly transfer it? In that case, you might want to move fast, clearly de fine what the bank owns, protect its rights, discover hidden obligations and – ultimately – think like an owner. In the process, you will likely increase an REO property's sales price by as much as 20%
Secret 1: Don't Let it Languish!
Quickly taking charge of a non-performing real estate development is one of the most important steps a lender can take to preserve and begin enhancing the development's value. The sooner you start, the greater your opportunities to reduce deterioration limit liability and generate goodwill you will need later.
Fact: Half-finished buildings deteriorate rapidly. The longer you leave them out in the open, the more value they lose. Simple steps such as installing roofing materials and waterproofing, and addressing drainage and erosion issues can halt further losses and reduce the likelihood of additional incremental expenses.
Fact: Unfinished developments are dangerous. Open trenches, heavy equipment and building materials are a hazard to everyone – especially children. Waiting to install fences, fill open trenches and remove other dangers increases the risk of liability, reputation damage and potential lawsuits.
Fact: The file may have just landed on your desk, but residents, neighbors and city officials have probably been complaining about deferred maintenance, late payments and other irritations throughout the foreclosure process. Waiting to address their concerns only fuels a fi re that can consume much of your time.
As soon as you take possession of a development, send a letter to residents, neighboring developments, city officials and other stakeholders. Tell them your institution owns the property and that you will address hazards and nuisances immediately. Then ask for a few weeks to get oriented. This almost always reassures stakeholders, buys time and begins building valuable goodwill.
Secret 2: Figure out What You Own
It is difficult to enhance the value of something you cannot define. But that is often the situation with non-performing real estate developments for which a bank becomes a reluctant owner.
As soon as you hire contractors to address unsafe conditions, start actively assembling information about exactly what you own. Begin with a thorough review of the property's most recent appraisal.
The sections about value are almost irrelevant, but other portions of the appraisal will provide detailed property descriptions, maps, photos, plans and so on. Property tax records may also be helpful.
Do not overlook the development's former owner as a resource. Although it seems counterintuitive, many former owners will provide abundant information about the development, its consultants and stakeholders. In addition, former owners are often the best source for plans, plats, regulations, third-party agreements and other pertinent documents.
Try approaching this step as though you were a buyer conducting due diligence. Adapting a buyer's checklist can help you focus on exactly what you need to learn and from whom. The importance of creating a complete defi nition of the property extends beyond your fi nancial institution. It will also help you increase the development's value by allowing you to present complete information to prospective buyers. The greater clarity and certainty you can off¬er buyers, the higher the development's sales price.
Secret 3: Protect Your Rights
The "entitlements," which are a property's zoning, land use or other development rights, are critical to its value. So it is imperative to identify those rights and protect them – and sometimes even extend them, because some entitlements expire if the property is not developed for a period of time. Further, if the existing entitlements do not fi t today's market, it is equally important to try to amend them for greater flexibility.
These days, the typical scenario is a development that was zoned five years ago for several thousand single-family homes targeting affluent buyers. Today, the development is REO and the market cannot absorb so much of that product – but the development might be able to serve different customer segments or price points. Can a new owner change the plan to include diff¬erent types of housing and perhaps retail spaces? That depends on the original zoning and on how much goodwill the owner has built with the local government.
If the original zoning plan allows some flexibility of density and product, it may be fairly easy to negotiate a new mix. If not, explore alternatives with local authorities. Perhaps the government is interested in having some portion of the property developed for empty nesters or seniors who would require fewer city services. Or it may consider revising the zoning in exchange for more open space.
In every case, your goal is to protect or obtain development rights that offer prospective buyers maximum flexibility – and thus, make the property more valuable.
Secret 4: Beware of Hidden Obligations
Some of the factors that affect a development's current and potential value are invisible. Developers often enter into agreements with owners of adjacent parcels or local governments that may include creating special utility districts, installing infrastructure and the like. Such agreements can generate significant revenue or significant costs, so you cannot aff¬ord to overlook them.
For example, a developer bought a large parcel of land several years ago when the area's housing market was superheated. Anticipating a rapid build-out and robust sales, the developer agreed to build fire stations on the property at specific future dates, rather than levels of build-out.
Today, the bank that owns this project is responsible for building fire stations to protect thousands of acres of empty land. Further, this obligation will transfer to whoever buys the development and will undoubtedly impact its sale price.
Thorough due diligence should reveal the existence of any such agreements, which may be possible to renegotiate. At the very least, a lender can clearly disclose such obligations to prospective buyers. Doing so will enhance a development's appeal, because buyers are always willing to pay more for a property whose opportunities and costs are clearly identified.
Secret 5: Think Like an Owner
Ultimately, maximizing the value and sales price of an REO development requires thinking like an owner, rather than a lender.
Lenders typically seek opportunities to quickly transfer non-performing real estate developments through a sale, hoping to recoup as much of the outstanding loan as possible and limit holding costs. Unfortunately, this perspective fails to recognize the potentially huge disparity between a property's value today and its potential value if the lender uses the strategies discussed above.
Owners tend to think strategically about a development: What is most appealing about a property in today's market? How much more could it be worth with di¬fferent zoning? How can I build goodwill with residents, local officials and other stakeholders? Have I discovered all the revenue opportunities and probable costs? How do those affect the development's appeal and value to a buyer?
When it comes to managing non-performing real estate developments, the real secret is to make a smart choice upfront. Maybe you can move an REO property quickly, especially at a re-sale price. Or you can apply the fi ve "secrets" presented above to increase the development's value by 10% to 20%. If you want to minimize REO losses and maximize REO returns, the choice should be simple.
Patrick Vedra has over 17 years of diversified experience in real estate, fi nance, leadership and strategy. As Managing Director of Carwin Advisors, he has advised numerous lenders on strategies for maximizing the value of distressed real estate assets.
Patrick Vedra can be reached at 214.765.0596 or email@example.com.
This article was posted on May 20, 2010, on the website of ABA Banking Journal, www.ababj.com, and is copyright 2010 by the American Bankers Association.