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July 13, 2008
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Foreclosure Crisis
Buying debt at deep discount

June 04, 2008 By: Wayne Tompkins


David Serle

Read more on foreclosure crisis
 

nvestors interested in buying distressed properties are increasingly using a different tactic to purchase desirable assets at a deep discount — buying the defaulted mortgage.

Investors are making an end-run around owners, buying mortgages on well-located commercial and residential properties, foreclosing and taking ownership of projects some lenders are increasingly desperate to unload.

“They are going to the mortgage companies and asking to purchase their nonconforming loans for 50 to 60 cents on the dollar. Sometimes even less,” said David Serle, vice president and managing broker at Re/Max Services in Boca Raton. “They then package these loans and foreclose on the properties. Now they have homes 40 percent to 50 percent below market value. They fix them up, and sell them for a profit.”

Although the strategy works for all kinds of properties and investors, commercial real estate is getting the most attention from big players with large pools of money who can buy mortgages in bulk.

“If the amateur investor did this it may not be worth the risk,” Serle said. “But when a hedge fund or a large group of investors do this they can keep several properties that do not sell, because they are making huge profits on the ones that are selling.”

Buying mortgage debt can put the buyer in a position to foreclose on the property. Then they can either acquire the asset at a discount or auction it off to the highest bidder.

In one prominent recent deal, property manager and investor ACF Riverfront LLC obtained the mortgage debt of Fort Lauderdale’s Las Olas Riverfront downtown entertainment and retail complex from Wachovia Bank. The buyer was assigned the mortgage with a principal of $22 million, as well as all leases and rents for the property.

The complex had sold for $31.9 million in July 2005.

Also, Ocean Bank, which in June 2007 filed a foreclosure against Villa Mare, a failed residential condo conversion project in Boca Raton, sold the loan to Laramar Group, a Chicago-based apartment investment company in December.

A foreclosure auction is scheduled for June 26, according to court records. Laramar Group, which has been operating the property as rental apartments since acquiring the loan, is expected to keep control of the property after the auction, said sources familiar with the property.

Real estate insiders like Serle view the trend as a sign that the standoff between sellers seeking the highest value and buyers looking for the deepest discounts is starting to thaw, breaking the freeze on deals in the real estate crisis.

“We see a lot more investors in our marketplace, which usually is one of the signs that the market will start to stabilize, and appreciate,” Serle said. “The South Florida real estate market is nearing the bottom, and the investors are trying to time it.”

While lenders and buyers are increasingly seeing eye-to-eye on such deals, lenders are not always surrendering unconditionally.

“I’m finding that banks are more and more sophisticated nowadays in terms of the economics of the deal. They don’t want to just give these away,” said Tom McCarthy, managing director of Carlton Advisory Services’ Palm Beach office. The New York City-based firm brokers deals between lenders and buyers of their debt. “They’re more than prepared in many instances to hold on to these assets and work them themselves, whether that entails foreclosure or workouts with the borrower.”

McCarthy said that’s a change from downturns in the ’80s and ’90s when, for example, the old Resolution Trust Corp., formed in the wake of the savings and loan crisis, brought a fire sale mentality to the disposal of nonperforming assets.

“The ideal situation for a bank is to sell a nonperforming loan to the end-users,” McCarthy said. “These banks get an awful lot of calls from buyers that are looking to spend 30 to 50 cents on the dollar and then flip it. They really don’t want to sell to a vulture looking to steal something under a duress situation. Most institutions are not in that position and most are not so anxious that they’re going to have to sell.”

Buyers seeking to use a property themselves generally are willing to pay more for it, and plan to make most of their money from developing it themselves, giving sellers more leverage in the deal as they seek to clean their balance sheets, McCarthy said. For the buyer, a debt purchase is a cost-effective way of acquiring the land they want.

Brokers do better on some deals than others. McCarthy said Carlton recently helped a lender obtain close to the full value — “in the upper 90 percent” — for debt on a particularly desirable Gulf Coast property.

“Someone really wanted that collateral, and it could be worth multiples of what it is today,” he said.

Many lenders aren’t waiting to be approached with offers, but are actively marketing their debt through brokers like Carlton.

In one example of a current proposal provided by Carlton, an “institutional seller” whose identity McCarthy would not reveal is offering $95 million of sub-performing and nonperforming commercial mortgage loans and $57 million of real estate-owned properties across Florida and five other states. Many of the assets have a land component in addition to partially completed townhouses, warehouses, retail and office space, or condominiums.

The assets are being offered on a competitive, sealed-bid basis.

Ultimately, the size of the buyer’s discount is tied to the seller’s motivation and the desirability of the properties in the debt package, said Ron Kriss, a real estate attorney with Akerman Senterfitt in Miami.

“Everything is supply and demand,” Kriss said. “Some of them are very nice properties and some are garbage.”

The best bet for buyers is to target banks with the highest rate of nonperforming loans, burgeoning real estate-owned property portfolios and concerns about liquidity and potential regulatory issues.

“That’s a seller that’s going to be very highly motivated,” Kriss said.

He said buyers come in every size and shape.

“The hedge funds take $15 [billion] to $20 billion and buy, in bulk, a huge $20 billion or so pool of defaulted notes,” Kriss said. “At the extreme other end of the gamut is the person who is willing to tolerate some risk, willing to roll up his sleeves and do some sweat equity and buys a foreclosure, maybe in his own neighborhood, and fixes it up himself on the weekend.”

That person finds a broker to sell it or rent it out in the meantime and makes a minor investment, makes a modest profit and does it again.

“Before you know it, he owns two or four foreclosed houses or condo units and he’s got a little business going on,” Kriss said. “He’s got tenants, some houses for sale and he didn’t even pool.”

In the middle are companies who are buying debt with $25 million or $30 million.

“This is happening and I’m seeing it at every single end of the range,” he said.

Not every buyer of debt is looking to foreclose on or take ownership of the properties whose debt it acquires.

Jacob Benaroya, president and managing partner of Biltmore Capital Group, a New Jersey-based bulk buyer and seller of nonperforming mortgage portfolios throughout the country, said his firm works to restructure and rehabilitate the loans. Once those loans are performing again, they can be traded for a higher rate — and a profit for the company.

“The cost of foreclosure and the holding period of defaulted paper that’s going through foreclosure can be up to a year in some states,” Benaroya said. “It might take a year to foreclose, there might be a six-month redemption after foreclosure, where we’re not allowed to do anything, which the borrower has a chance to redeem, and then there might be an eviction process on top of that.”

After 18 months or so, the buyer ends up with a property that it puts on the market, “all the while maintaining, preserving, paying all the taxes and the insurance and then waiting for it to sell at a price that hopefully can generate a profit after all of these expenses and the cost of that loan.”

The discount rate also can be deceptive, he said.

“Just because somebody’s debt is selling at 60 or 70 cents on the dollar doesn’t necessarily make it a good deal,” Benaroya said. “For instance, if you had a $200,000 mortgage on a house that’s now worth $100,000 and you go buy that debt for 70 cents [on the dollar], you’ve just lost money.”

Serle said he sees debt purchasers gaining a stronger hand before the downturn ends.

Some lenders will be increasingly willing to sell debt at discounts, he said, “because they’re either going to have just an absurd amount of property, maybe double or triple what they have now, or they’re going to be forced to give these away at 30 or 40 or 50 cents on the dollar.”

Benaroya said sellers and the end-users they most covet have some hurdles to overcome if they are going to find each other.

“For end-users, there’s a high barrier to entry with the lending institutions that are holding the paper to sell you the debt,” he said. “It’s not like an REO property where it’s a piece of property they want to get rid of. If you have money, they’d be happy to sell it to you. When you’re buying debt, there’s a lot of regulation and there’s usually an extensive approval process by the seller of the debt. You’re buying someone’s mortgage and there’s a homeowner at the other end of it who needs to be treated fairly.”

As is often the case in economics, the big players are in the best position.

“Unless they buy in tremendous bulk, they’re not going to be able to entice the bank to take the hit,” said Michael Sichenzia, chief operating officer at Dynamic Consulting Enterprises, a Deerfield Beach firm that helps consumers work out mortgage debts.

At the same time, he calls debt purchases “the future of the banking business from an entrepreneur’s point of view. This is a golden opportunity for investors who know how to compensate for risk.”

Purchasers of debt in South Florida stand to do well because, he said, “bricks and mortar and land have a certain value. There’s a limited quantity of dirt. In Florida, it’s getting to the point where you can buy condos for less than the dirt price.”

Wayne Tompkins can be reached at wtompkins@alm.com or at (305) 347-6645.

David Serle photo by Richard M. Brooks


Reader's comments
Ann said:Typical of a realtor to say it is bottom and that is why the investors are buying..yet if you read his article, the investors are really hedge funds that can handle the wait game for the market to finish its correction whether it be 1,2,3,4 or 5 years(they are also buying at enough of a discount that the revenue produced by the property can provide a positive or flat cash flow)..a correction does not mean a automatic curve up..a correction also means a period of a flatline..where no appreciation or depreciation exist..until we hit that, this market is not near the bottom.... . June 4 at 11:07 a.m.

Me in Mass said:So they are willing to take $.60 on the dollar from investors but not write down the pricipal for the current owner - great. June 4 at 11:15 a.m.

MILLION said:from the article, “The ideal situation for a bank is to sell a nonperforming loan to the end-users,” McCarthy said. “These banks get an awful lot of calls from buyers that are looking to spend 30 to 50 cents on the dollar and then flip it. They really don’t want to sell to a vulture looking to steal something under a duress situation. Most institutions are not in that position and most are not so anxious that they’re going to have to sell.” most institutions are not in that anxious position YET. they will be soon enough and those offers at 50 cents will start to look generous. why do you think the FDIC is warming up for record bank failures over the next few years?? and by "record" i don't mean the number of banks that fail, i'm referring to asset volume that goes into FDIC receivorship. June 4 at 12:33 p.m.

David Serle said:Ann I believe you misunderstood my quote. What I was saying is that it really has been several years since the investors have entered the market place, and because of this and several other factors that in certain areas the market will stablize, and eventually appreciate. Ann, my question to you is are you in the real estate business or in some area where you see something different than I am. I see properties being sold at 2001 to 2002 levels. They may continue to decline, but when will it stop. Noone knows that nor can they time the bottom. I look at the most influential investors of our time, and they are starting to invest in real estate. Would you rather buy in a "hot" market or a declining market? Ask someone who bought in 2005 that question. It is much better to do the opposite of what every one is doing. Me in Mass I agree it would be nice for a bank to give the discount to the current owner, but than what happens to the owner a few doors down that has been current on his or her mortgage? Should banks just reduce the principal of all loans? Do you know nearly 70% of borrowers that have missed payments on their mortgages never contact their banks to see if they can help them? Banks are a lot more motivated to help their struggling borrowers. Banks are not entirely in the right, but the assertion that banks should just cut the principal of notes that the customer defaulted on would create a larger problem. June 4 at 1:59 p.m.

jgl saidI think the issue is more that the "owners" have no equity in the properties so all the loss is absorbed by the banks. And the balance sheets of many of these banks so are bad that they don't have the capital to offset the losses on these loans without going chapter 11. I think this is the more likely reason for hesistancy to sell at a steep discount. June 4 at 6:05 p.m.

jgl said: I think the issue is more that the "owners" have no equity in the properties so all the loss is absorbed by the banks. And the balance sheets of many of these banks so are bad that they don't have the capital to offset the losses on these loans without going chapter 11. I think this is the more likely reason for hesistancy to sell at a steep discount. June 4 at 6:08 p.m.

Real Estate is Finished said:Real Estate is Over. Thank God. June 5 at 1:40 a.m.

Draino said: Me in Mass said: "So they are willing to take $.60 on the dollar from investors but not write down the pricipal for the current owner - great." Disgusting, isn't it? These lenders and "investors" are scum. June 6 at 11:47 a.m.

Zeppelin said:Hang them all!!! June 5 at 2:18 p.m.

Andres said: David, I think you are mentioning the right points in here. Let me ask you this, are you seeing SFHs cash flowing as of today? I am starting to see those deals in the Washington DC area, and I assume the same should be happening in places like Miami, Ft. Lauderdale, Naples or Tampa. What is your perception at this point? June 6 at 10:05 a.m.

The Truth said: Those people that are bashing lenders and investors are the ones that are most likely upside-down on their own investments or residences, which they bought hoping to get in on the action but failed because the music stopped and now they have no chair to sit on. The lenders are responsible for the bubble because they made it too easy to borrow but they were just as greedy as most of those who signed the dotted line on the mortgage documents. You want the banks to give discounts to homeowners that put $500 down and ended up with a $500,000 property so when the market comes back that homeowner will get all the upside. How fair is that? The lenders are selling at the discount to people that can give them cash today so the banks can survive. Can the borrower offer them cash? Let those spenders that bought into the frenzy be foreclosed upon and let the ones that were conservative be rewarded for saving money and having discipline to wait till things get normal again so they get a chance to buy at reasonable prices. Did anyone bail out those who bought hi-tech stocks in 1999 and 2000? Bottom line: you can't be a capitalist on the way up and a socialist on the way down. P.S. I am somewhere in between the spenders and the savers so I am feeling some pain too but I don't expect anyone to give me a free ride. June 6 at 12:05 p.m.

David Serle said: Andres, Thank you. I assume you are talking about single family homes having cash flow? In Florida it is tough because our taxes and insurance are so high that it hurts the ability to receive positive cash flow from rental income. However it is starting to be closer, and when you look at the affordability of purchasing vs. renting it is starting to be the same. When that happens or it becomes more affordable to purchase than to rent you will see a small appreciation from year to year. June 6 at 5:06 p.m.

Jonathan Levy said: I'm a fund manager in Miami and I've met with all of the regional banks and most of the nationals, and my experience over the last 12 months has been that the banks have been completely unrealistic in their pricing expectation of debt backed by multi-family and condo-hotel assets. The failed condo-conversions are still being marketed by the banks on condo-conversion fundamentals and not current cash flow underwriting, so that anyone who acquires the debt today will have an investment that at best is not yielding any income and at worst is realizing a negative return. Add the costs to foreclose and the only buyers today at such pricing must be the least risk-averse and most cash-rich of speculators. We're taking a wait and see approach. There's absolutely no incentive to get into the market at this point, the spread between the bid and ask is that far apart. Look to 2009 and 2010 when the 5 year interest-only loans backed by office and retail assets acquired in 2004 and 2005 come due; pro-formas, lease-up expectation, rental rate growth and underwriting in those years were extremely aggressive and much of the secondary and tertiary market product (and some of the grossly-overpaid for Class A product) is going to be in negative-equity territory when it comes time for the owners to place new financing. June 7 at 10:37 p.m.

Financial Expert said: Nothing but another ad to sucker fools in at prices that are still to high. Don't pay more than 20 cents on the dollar. Jume 8 at 12:25 p.m.

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