Real Estate Concepts - December 29, 2023

Distressed Assets — What, Why, and When

December 29, 2023

Abby Blumenfeld
By Abby Blumenfeld

Investing in Distressed Assets — What to Know

A “distressed asset” refers to an investment in real property that is priced below market value—typically due to solvency or cash flow issues on the part of the asset’s current operator, manager, or owner. These investments can take many forms: equity positions, partial equity interests, structured notes in the middle of a capital stack, or even senior loans. In layman’s terms, a distressed asset is a bargain that can be seized upon by well-positioned real estate investors. Like any other bargain, these bargains would cease to exist if the market for distressed assets were perfectly competitive. Distressed asset opportunities arise at particular moments when the seller is encumbered and the market for such properties is relatively cool, creating a demand mismatch for capital.

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The ability to realize value from a distressed asset rests on a couple of things:

  • Being able to identify and acquire the distressed asset at an optimal moment, given broader market and asset pricing dynamics.
  • Having the resources, experience, and wherewithal to realize the untapped value of the distressed asset by managing through sale, repayment, or other resolution. 


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Key Takeaways:

  • Future return potential is dependent on future cash flows, and hence depends on unlocking asset value.
  • Successful distressed asset investing requires experience, scale, and competitive advantage.
  • Access to distressed asset funds was extremely limited during the years following the Great Recession. EquityMultiple is working to offer distressed asset investing, alongside quality sponsorship, to accredited individuals.
  • Distressed property opportunities may emerge in 2024 and beyond due to current capital market dislocation.

Distressed assets are considered by some to be counter-cyclical investment vehicles and attractive diversification options during moments of public market volatility. Most fundamentally, future returns are determined by the future cash flows of an asset weighed against the price paid for those cash flows. Distress allows professional investors to capitalize on a lower price while also optimizing those cashflows through expert management.

Distressed Assets During Economic Downturns

Distressed asset opportunities arise far more commonly during economic downturns for reasons one might expect:

  • An operator or asset manager (the current owner of the distressed asset) faces decreased demand for space or units at their property, whether the asset is an office building, a multifamily property, retail, or mixed use. Hence the operator may face increased vacancy, be forced to lower rents in order to retain tenants, or both. 
  • The current owner of the distressed asset faces other business challenges, such as an inability to retain a property management firm, that make it difficult to maximize value of the asset. 
  • The current asset owner expedited to exit the asset but, as a result of unexpected adverse economic conditions, is now forced to sell the asset at a lower price.
  • Lower valuations across markets can push real estate lenders to “mark to market” their loans due to pressure from their auditors, in turn causing pressure on regulated reserves. During the last downturn, this created opportunity in the purchase and sale of debt securities.
  • Some lenders are not equipped to own real estate. When underlying distress affects an asset to the point that a lien holder no longer wishes to invest in it, lenders may want to sell their position to avoid the difficulty of working out the problems.

During the Great Recession, several large, national investment firms – such as Lone Star Funds – established successful funds predicated on the acquisition of distressed real estate assets. The scale, expertise, and capitalization of these firms allowed for opportunistic acquisition of distressed assets across markets and throughout the recovery period. These funds focused on distressed real estate assets during this time purchased distressed debt, portfolios of distressed loans, equity, CMBS, or some combination thereof. 

A sponsor Q&A for a recent EquityMultiple distressed asset investment. A non-performing loan (NPL) is a form of distressed debt.

Finding Distressed Properties in 2024

As of this writing, we are not in a recession. Not even close. While the surge in interest rates could still tip the economy into recession, a downturn is far from certain. We find ourselves in a unique moment, however. While many economic indicators (such as job growth) do not show distress, there may be plenty of investing opportunity among distressed properties in the years ahead. This is because interest rate hikes have increased the cost of capital for real estate operators dramatically and precipitously. It is common for real estate operators to take on floating rate debt or incorporate refinance into their initial business plans. When interest rates rise dramatically, servicing preexisting debt or taking on new debt may be untenable. This could force sales of real estate assets that are otherwise well-positioned.

In other words, distressed assets may come to market at a time when the general real estate investment thesis remains strong in many sectors and local markets.

But how do you find distressed properties in 2024 to invest in? For most self-directed investors, you aren’t going to find them in a phone book. Distressed assets are often transacted on auction platforms or in opaque private markets. In today’s market, a successful distressed asset investment will likely mean investing alongside an experienced operator who benefits from strong capital availability and the wherewithal to restructure the financing of a distressed property where debt service became untenable for the seller / prior operator.

Distressed Asset Investing — Assuring Quality

Success in distressed asset investing requires experience; the ability to accurately assess distress and opportunity; and sound strategies for realizing value and managing through uncertain times. 

The following strategies may come into play as an experienced investor targets a distressed asset:

  • Purchasing distressed debt at a discount to the value of its underlying asset collateral;
  • Restructuring non-performing loans, or a multitude of loans sold in a portfolio. 
  • Installing “asset turnaround” strategies – borrowers in distressed debt situations often expect to ultimately lose the asset to foreclosure, and hence have ceased to practice quality asset management. Distressed debt investors may realize value by implementing better asset management strategies, including the creation of a dedicated entity to manage the property. They can also provide additional capital at far higher rates, given their priority position. 
  • Engaging in complex transactions that increase barriers to entry and lower competition. 
  • Leveraging a trusted industry name to engage in off-market transactions, further reducing competition and improving basis.

The rehabilitation of distressed assets entails significant legal knowledge, investment agility, and asset management acumen. Distressed asset investors may take advantage of interest rate risk and dislocation in capital markets following the most rapid rate of interest rate hikes in several decades. Operators who took on floating rate risk, or who must now refinance at significantly higher rates, may be forced to liquidate in the years to come. This trend should yield distressed properties coming to market, and opportunity for distressed asset investing by experienced, well-capitalized operators. Unlike in prior periods, individual investors may be able to tap into these distressed properties fractionally and passively.

 

Reporting from Bloomberg on the current outlook of distressed real estate fund managers.

Access to Distressed Assets

While large investment firms were able to achieve sustained success during the Great Recession, individual accredited investors enjoyed little access to quality, private distressed asset fund structures. In the years since the JOBS Act, a number of real estate crowdfunding platforms rose to prominence by offering private-market real estate to individual investors. During the longest bull market in U.S. history, investor sentiment was strong and asset quality varied. All investments entail risk, but opportunistic or distressed asset investments may entail the longest list of risk factors. EquityMultiple takes a strong approach toward asset selection and investor protections. While access to distressed assets may be greater than ever before, it is worth considering the operating model of any platform that offers distressed asset investing. Be sure you understand the business plan and risk factors. 

Distressed Assets — the Bottom Line

EquityMultiple offers accredited investors the chance to engage in the distressed asset market through carefully vetted commercial real estate investments. Our platform provides access to a variety of investment opportunities, from debt to equity, including distressed assets poised for significant returns. Our goal is to present distressed asset investment opportunities, alongside quality fund sponsorship, at relatively low minimums.

Why Choose EquityMultiple?

  • Expertise: Our team’s expertise in commercial real estate and distressed assets ensures the selection of opportunities with a favorable risk-reward profile. We leverage our industry knowledge to identify and curate investments that promise high returns while managing associated risks.
  • Access: We grant access to investment opportunities typically reserved for institutional investors, encompassing a diverse portfolio of distressed assets, from commercial properties in need of revitalization to debt instruments offering attractive yields.
  • Transparency: Our platform delivers detailed information on each investment, including risks, potential returns, and the strategy for value creation. Investors can make informed decisions based on the comprehensive data and analysis provided for each opportunity.

If you would like to discuss distressed asset investing with our Investor Relations Team, please feel free to reach out at ir@equitymultiple.com or schedule a call.

Distressed Asset FAQs

Q: What makes an asset “distressed”?
A: An asset becomes distressed when its owner faces financial difficulties, rendering it unable to meet its obligations and leading to a significant reduction in the asset’s value.

Q: Are distressed assets a good investment?
A: While distressed assets can offer high returns, they come with high risks. Investors should carefully consider their risk tolerance and conduct thorough due diligence before proceeding.

Q: How does EquityMultiple select distressed asset investments?
A: EquityMultiple conducts comprehensive due diligence, leveraging our team’s expertise to select opportunities with a favorable risk-reward profile. This includes a thorough analysis of the asset’s financial health, market position, and potential for recovery.

Q: What is the minimum investment required for distressed asset opportunities on EquityMultiple?
A: The minimum investment varies by opportunity. Please visit our platform for the most current information on available investments, typically starting from a threshold accessible to a broad range of accredited investors.

Q: Can investing in distressed assets lead to losses?
A: Yes, given the high-risk nature of distressed assets, there is a potential for loss. Investors should be prepared for this possibility and consider diversifying their investment portfolio to mitigate overall risk.

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Abby Blumenfeld
Abby Blumenfeld
Abby Blumenfeld is the Senior Investor Relations Analyst at EquityMultiple. Originally from Massachusetts and a graduate of Quinnipiac University, Abby has an extensive background in both commercial and residential real estate. Before joining EquityMultiple, she gained experience working with commercial properties at Cushman and Wakefield. Her experience includes both the New York City and Boston real estate markets. At EquityMultiple, Abby is responsible for developing relationships with prospective investors, ensuring clear communication, and serving as the primary point of contact for investors. If you reach out to EquityMultiple, there’s a good chance you’ll interact with Abby during your journey. Outside of work, Abby enjoys playing pickleball, tennis, and traveling.

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