Distressed Opportunities: Necessity remains the "Mother of Invention"

My first opportunistic real estate deal was co-brokering the sale-leaseback of a 3,100sf medical office condominium in NYC.  It was a “distressed” sale.  The seller needed to liquidate the holding for personal reasons but still wanted to operate a medical practice at the location.  It was a good deal for both parties – cash for the seller, cash flow for the buyer – and borne out of necessity.

Almost every sector of the real estate industry has been impacted by the economic downturn caused by the Coronavirus pandemic and the headlines scream DISTRESS:

• Will Coronavirus Kill Downtowns?

• Offices may never be the same again as the coronavirus pandemic boosts technology disruption

• A rise in remote working could crater expensive housing markets

• Hotel industry decimated by COVID-19 pandemic; owners say it’s worse than 9/11

• Retail ‘apocalypse now’: Analysts say 75,000 more U.S. stores could be doomed

• Office landlord sells assets as it wonders how many tenants will return

Co-opting Newton’s Third Law of Motion on equal and opposite forces, means someone’s distress is another’s (perceived) opportunity, which is why we see intertwined among the reported demise of real estate, a similar amount of ink gushing over the $140bn+ in funds focused on opportunistic/distressed asset investments.   These funds are dominated by behemoths such as Blackstone, Brookfield Asset Management, Starwood Capital, Fortress Investment Group, and Apollo, with massive war chests. Other players, like real estate technology start-up Cadre, are raising funds to seize on property market opportunities, as are multitudes of other firms, large and small.

The ever-present and oft-asked question is: “Where will we see opportunities?”  The answer: maybe not where you might think.  Traditional owners of real estate generally have cash reserves and access to capital that can cover shortfalls arising from temporary market disruptions.  Newly minted lender forbearance programs and relief for some renters give owners a brief reprieve as well.  Right now, every owner and investor is re-evaluating their 2020/2021 business plan and looking to stabilize property operations (and cash flows) before considering placing properties on the market.  Delays in transacting arising from “social distancing” challenges in touring sites and conducting due diligence further restrain sales activity.  For the meantime, it may be more productive to look elsewhere for Coronavirus-related real estate dislocations.

An underreported real estate opportunity, which should become more prevalent over the next 12-18 months, are situations where real estate ownership is ancillary to the owner’s main business, which itself is facing extreme hardship due to the Coronavirus pandemic.  These owners are selling out of necessity (like the doctor in the opening paragraph) and the opportunities come in many forms:

• Small to mid-size business owners, like the Tri-State area automotive equipment shipper or demolition contractor needing to sell non-essential real estate holdings (e.g. apartments, mixed-use) in order to raise cash to support a struggling business

• Airbnb hosts (either the portfolio owner or single-unit lessor) who now find themselves sellers instead of hoteliers (or landlords) in the wake of a $1.5b loss in bookings. It is reported that 50% of Airbnb hosts rely on the rental income to stay in their own homes and avoid foreclosure.

• Publicly traded companies such as BigLots or Bed Bath & Beyond who are selling billions of dollars of real estate in sale-leaseback transactions to firms like Oak Street Real Estate Capital in order to reduce debt and stabilize cash flow

For sure there will continue to be large, headline-grabbing, transactions by institutional real estate owners that are looking to raise liquidity (SL Green) or preserve capital (Paramount Group) as tenants struggle to pay rent, leasing slows down, and development pipelines stall. I am not sure defensive measures by well capitalized firms will qualify as “distressed” (see Paramount’s 10% sale of 1633 Broadway at over $1,000psf, as an example), so instead, the next generation of Grave Dancers should look for instances where necessity is the driving force.  Blackstone believes it could take up to a year for owners to run through reserves, so be patient and happy hunting.