Purchase Distressed Commercial Properties

Buckingham lawyers David, Richard and Nate talked with me previously about PPP loans in the commercial real estate space, and how real estate investors can stabilize themselves through the state shutdowns. With their extensive experience in receiverships and bankruptcies, all three of them understand the potential trajectory of many businesses that are on the edge of failing. 

Speaking specifically to business owners and real estate investors, David, Richard and Nate have some strategies for you to capitalize on opportunities created by the pandemic. And as lawyers, they have the inside scoop for how you can uniquely keep tabs on distressed properties through the court system

Liquidity is Going to Be King

I’ve heard that Fannie Mae and Freddie Mac are starting to require a whole year of cash to be put into an escrow account. This could mean tying up $500,000-$1,000,000 in cash. At a time when liquidity is being squeezed by lenders pulling back and tenants asking for forbearance loans, setting aside such a large chunk of cash can really put a crimp in the kind of deals you can jump on. 

Over the next 6 months to a year, it’s going to be a long game to stay liquid. For businesses that took PPP money, they’ve been able to keep people on the payroll. But if your industry was affected by the shutdowns, then you’re trying to balance that payroll with reduced income. For many business owners, that means it’s time to cut expenses to the bone and hold off on capital expenditures until things settle down. 

I have friends of mine who’ve been setting aside their cash anticipating the recession that we were overdue for. Of course, now we have the pandemic that not only pushed us into a recession, but has also exacerbated any problems we might have had anyway. For those investors who were already preparing for a potential recession, and who’ve been keeping their powder dry waiting for distressed properties to come on the market, Richard has some advice for you about what’s coming down the pike.

Cash Out Refinancing and Other Strategies

We don’t have a crystal ball to know how long it will take before we start seeing the effects of COVID on the housing market. You could have 60, 90 or only 180 days to put yourself into a position that’s ready to purchase discounted properties. But Richard is already seeing advantages for real estate investors, including investors who were facing some distress before the pandemic. 

The interest rate for residential loans is amazing right now, and even for commercial loans, I’ve seen it around 3%. That is a killer rate, and that makes refinancing a no brainer. If you have a strong balance sheet, you should definitely consider a cash out refinance and pull out a couple hundred thousand so that you can free up liquidity in your assets. 

Not everyone who’s going to be selling is going to be in distress. Older landlords just don’t want to go through another recession, and might be ready to cash out and retire after 20-30 years. So while they might not be in distress, they might notice the crowd of buyers thinning out as hard money lenders pull back and liquidity dries up. That’s great news for any investor still left in the game, and it gives them a fantastic opportunity to retrade on any previously agreed upon prices.

Preparing for Defaults

Normally, it takes about six months to see those defaulted properties wind their way through foreclosure, but the statewide shutdowns put a pause on all of those normal court functions. Once courts open back up, they’re still going to be dealing with emergency orders and the enormous backlog that they have to work through to catch up. But Nate assures me that the foreclosures are coming; they’re not going to just be a file and immediately liquidate kind of situation.

In judicial foreclosure states like Ohio, commercial properties that are being foreclosed on are going to come through a third party like receivership. The receivership has fiduciary duties to the courts and the creditors, but as receiverships increase, banks will be looking for alternate ways to clear off their books. Those are some of the properties that investors with cash can pick up.

With impeccable timing, the Small Business Restructuring Act just became official this year. This act makes it easier and more affordable for small businesses to file Chapter 11 bankruptcies. Additionally, in the CARES Act, lawmakers amended the debt cap, so you can have seven and half million and still file. Nate predicts that we’re going to see a lot more Chapter 11s acting like a giant liquidation sale. We’re going to see a lot of sales come out of bankruptcies, and it’s either going to be a debtor in possession, a small business reorganization trustee, or a court appointed receiver that will be the point of contact for these sales.

Conclusion

If you’ve decided that you’re not going to miss your chance this recession to get in on some basement-level prices, then you’re going to want to know how to find distressed commercial properties like these. You have to have relationships with people who are in the know about these properties so that you have a heads up before they come on the market. Real estate attorneys, especially those in foreclosure or bankruptcy, commercial brokers, court-appointed receivers, bankers in the special-asset groups, and auctioneers in your local market are all the kind of people you need to connect with.

Besides meeting the people who have access to this information, you can also find a lot of this information yourself online. You can access court records, federal filings or set up a Google alert for court dockets or court wires. If you know the owner of a building that you suspect is distressed, you can also set up an alert for their name in bankruptcy dockets to keep an eye on the building.

These strategies for finding distressed commercial properties are next level. While everyone else is waiting around for listings to hit the MLS, you can get a head start by connecting directly with the real decision makers who are to help you build your real estate portfolio through the recession.

Be daring,
Josh

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How to Purchase Your First Multi Family

Jack Petrick and I have been good friends with each other ever since we met through our kids’ soccer team. I’ve been one of Jack’s primary private lenders on a number of his buildings, and we’ve purchased multi-family units together as well. Jack was a firefighter who did real estate on the side. Like many firefighters, he was determined to stay until he got a pension, but he left when he realized that he could make more from the laundries in his apartment buildings than he could on his firefighter’s salary.

As business partners, Jack and I work well together. I raise the capital and Jack looks for properties. This property that we purchased about a year ago in Shaker Heights is Jack’s first big multi-family purchase. We raised $2.2 million for this off-market listing, and Jack’s been onsite making sure everything is running smoothly.

In the next 6-24 months, you’re going to start seeing more deals like these hit the market. People who bought properties at retail prices are going to start hurting when their apartments go empty or their tenants stop paying rent. We’ve pivoted away from private lending for the last year and built up our cash reserves so that we would be ready for the housing recession that we knew was coming.

This is why our approach is to find distressed properties and purchase them at a discount. When a recession hits, we can weather the storm because we can have a little bit of vacancy. Our margins are just better because we didn’t pay retail prices. That’s why we buy properties with deferred maintenance, terrible property managers, low occupancy, low rents, or absentee owners because those distressed properties are the best bang for your buck.

Find Off-Market Distressed Properties

This Cleveland Heights property that we just closed on was the first off-market property that Jack’s been able to close on, and it has opened the door to tons of other off-market properties. Purchasing a multi-family property is not like purchasing a residential property. Brokers don’t want to stick their necks out for you, so you have to prove to them that you have what it takes to close on this deal.

Jack says that you have to show that you have personal integrity. That means showing up, communicating well, responding to phone calls, and texts, and never leaving the brokers any doubt that you absolutely want this property. It was a big growth opportunity for him to purchase this property because it was six times larger than any deal he’d ever done before. All told, the purchase price was $9.2 million, and we raised $2.2 million together for it. Once we get it renovated, it should appraise $14 million for the refinance.

Increase Profitability In Business Operations

We aim to buy properties for 65 to 70 cents on the dollar. That way, we can withstand a 20%-30% vacancy rate before we’re upside down. We leave ourselves a huge cushion before the building ever becomes at risk. But remember, we’re also buying distressed properties so we have a lot of ways to make small improvements that will move the needle on our profitability almost immediately.

For example, in this Shaker Heights property, the old owner was only claiming around $5500 of the laundry money. We were able to do some adjusting, fix some things, bring the cost in line with today’s prices, and now we’re running close to $25,000. This little fix brings in an additional $300,000 without much effort on our parts.

Now we can go through the units and continue to make improvements that will affect our bottom line. Upgrades in the kitchens or bathrooms, doing our water conservation, getting rents bumped up to market prices, and other small improvements immediately improve the cash flow on the property.

Renovating a Distressed Multi-Family

While this property was incredibly clean, it was dated with a very 1990s white and gold vibe all over it. We had 164 units, and Jack’s been working on getting every unit painted and updated. The updates give us the opportunity to bump up the rents, but it can be difficult to get in and paint occupied units. COVID doesn’t make things easier since people are reluctant to open up their homes.

When Jack started planning the renovations, he was going to send in one crew to do all of the caulking, painting, countertops, flooring, and the rest of the work. But he quickly found that it was more efficient to create one crew that did one job, like painting. That crew could get in and out faster and more efficiently. Since we purchased the property nine months ago, Jack and his team have finished renovating about 94 units, which is exactly where we want to be at so that we’re prepared for the refinancing next year.

Our ideal leasing period is May, June, and July, and this building’s already in that sweet spot. As tenants start moving in or renewing their leases, we’ll start increasing the rents to raise them closer to where they should be. The increase in rent will be easier to handle because the tenants that stay will get a recently remodeled apartment in return, and the new tenants will be paying the same amount they’d pay at any other Class B building in the city.

CONCLUSION

When you purchase your first multi-family, remember that the goal is not to pay the retail price. By paying 50-70 cents on the dollar, you’re going to give yourself enough room to handle any unexpected expenses or economic downturns. Don’t neglect the business operations though. That’s your chance to move the needle toward greater cash flow for the next ten, twenty, or thirty years. The next 6-24 months is going to provide an unprecedented opportunity to purchase distressed properties at significant discounts. Are you ready?

Be daring,
Josh

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