By Peter Berman, chief executive officer, The Ruby Group
According to data from RealtyTrac, lenders took back an estimated 1,147,000 properties from owners in 2011, and projections for 2012 are currently calculated to be 750,000. Many these were new vacant homes owned by builders and developers. Despite the absence of precise data, it is well understood that these failed new home developments are significant.
In previous significant downturns that resulted in lender and government organized relief, such as the Resolution Trust Corporation (RTC), Real Estate assets were liquidated at tremendous discounts. This liquidation involved the closing of many institutions including but not limited to Savings and Loan Institutions. In this process windfall profits and great fortunes were made by well positioned developers and investors. The recent downturn has been treated differently. Many local banks have held on to these assets first by “Extending and Pretending” the loans and then by taking title to the property. This presents a myriad of challenges for the lender; they have now become a de facto developer often with the most challenging projects and a dynamic regulatory environment.
Developers, recognizing the opportunity this presents, are well poised to capitalize on the situation. Quite often lenders are in a position where a sale of the land is extremely complicated and difficult due to a murky sales projection environment and unknown variables arising from the previous developer’s actions. A developer with strong operational and building capabilities can offer a variety of services to lenders. These can be structured as Consulting or Lender’s Representative agreements.
Land is like a foreign currency to lenders, so by collaborating with developers, they can exchange this burden for something of actual value to them — cash flowing debt.
One challenge is that many lenders are reluctant to sell off reclaimed properties at the current market price. Selling at a rate that’s currently quite low means that lenders have to take the capital loss, which is never an appealing prospect. Exactly how much it costs the lender to own the property will determine just how motivated it will be to sell. However, this cost can be difficult for the lender to calculate, anticipate and comprehend.
The Real Estate development business has gotten exponentially more complicated, and lenders underwriting was not oriented towards understanding the myriad of environmental and stormwater compliance costs and regulations.
Lenders must be presented information that helps them recognize the extent of the burden they’re dealing with when they take ownership of distressed development properties. The actual value of these properties is often considerably less when you factor in all of the costs associated with ownership. Because lenders aren’t usually in the business of developing properties by themselves, there is no added value given to the property during the period in which they own it.
While banks might prefer to wait for the market to improve to the point where distressed development properties will carry a higher price, the property taxes, insurance, maintenance of infrastructure and costs associated with maintaining approvals will have eaten up a significant portion, if not the entirety, of that price appreciation. There’s also the negative public perception that is evoked by a promising development site turned into a bank-owned lot. People see a failed project sitting on fallow land, and are likely to associate that failure with the lending institution’s brand.
With these challenges come some big opportunities for both developers and lenders. Banks can work with a developer by putting in any pre-construction work that their sites require. This type of work can make properties much more attractive to builders and developers, as it helps them avoid early bottlenecks in the construction process. For this minimal investment, lenders will be able to fetch a much fairer price on the market. Developers are also much more likely to flock to lenders that are willing to take on this level of responsibility for the properties they own, however short that period of ownership may be. Instead of being stuck in the untenable position of either having capital being chiseled away by property taxes and carry costs, or by selling at a capital loss, banks can stabilize the value of properties that they reclaim, as well as recoup a significant amount of their total investment in the property by selling it to builders and developers for a better price. This approach could help lenders and developers avoid the type of standoff that has become all too common in negotiating the sale of distressed development properties.