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