As the US economic downturn began to take shape in 2008, many funds began scanning the landscape to position themselves to steal a distressed asset deal. Consequently, being financially positioned to take advantage of a down market, all the funds had to do was wait a little while for the banks to begin unloading distressed properties. Undoubtedly, lenders would need to clean house and divest themselves of bad debt now sitting on their books. However, the thirty-cents-on-the-dollar deals just didn’t materialize. What happened?
Two major factors came into play that changed the landscape. First, new changes in governmental regulations allow banks to leave the asset values “as-is” without incurring additional write-downs. Second, the Federal Reserve’s monetary policy allows banks to borrow at close to zero interest. As banks made new loans, or perhaps simply invested in treasuries, big profits are the results. Thus, the banking industry is recapitalizing and will soon be better able to write-down the bad loans. As we gradually move through the recovery, book values and market values will improve and become more aligned with one another enabling the banks to sell their loans and not adversely affect their balance sheet or impair book values of similar assets.
Today, we are beginning to see many of the advantageous loan terms originated in prior years begin to mature. In some cases, floating rate or interest-only terms are beginning to expire. New opportunities are developing in the market place. As values have bottomed and are looking to rise, lenders will become more motivated to dispose of distressed assets. As these factors come to bear on financial decisions, we expect distressed assets to reach the market in greater and greater numbers throughout 2010 and 2011. For those who have been patient, the opportunity to invest in distressed assets at prices that make sense to the buyer and the seller will become more common. How then should we prepare and plan to take advantage of these inevitable opportunities?
Depending upon whether we are actively looking for a distressed asset or there is a possibility of being handed one by default or bankruptcy, we need to be prepared with a plan to take advantage of the situation. Unquestionably, taking over an asset will cost money. With the proper plan, these costs can be minimized and most likely even recovered depending on whatever our company decides to do with the facility.
The first part of a distressed asset plan should focus on preserving its value. Because distressed assets come in many shapes and sizes, all plans should be flexible but include at least the following three parts. The information obtained from these steps will provide an informed decision and decisive plan.
- Site inspection — Knowing the condition of the facility enables the prospective owner to develop the best strategy for using or selling the asset. A site inspection by a competent inspection team with experience in construction and/or management of that type of facility should be completed. Often the team includes an operations manager from another facility or a third party expert such as Hill International. Information contained in the report must include the status of construction, life safety equipment, and the overall site conditions.
- Protection of the facility — One of the key and possibly most overlooked tasks is whether there are immediate steps that must be completed to protect the facility and the public. As a Purchaser or a Lender, unfunded and unanticipated operational costs are a very real challenging issue. Protection items should include making sure all of the life safety equipment is active (i.e. sprinklers, fire alarm and security). Validating that the building is protected against the weather, the air conditioning is operating as a protection from mold growth and even items as small as if the garbage is being collected. Piles of debris outside the front entry may also seriously impact public opinion and the value of an asset.
- Cost to complete or remediate — The third step is evaluating the cost of items required to finish or repair facility items. If the facility is partially finished, what will it cost to complete construction? Are there any liens on the project? How much is the general contractor owed and are they even willing to finish the work? Is there substandard construction that will require repairs or replacement? These items should be analyzed through a cost to complete analysis. Developing construction costs should be done by an experienced team of professionals. Even if you have the in-house capability to prepare a construction estimate, we recommend hiring a third-party expert experienced with distressed properties. Their experience will identify many aspects of incomplete projects that are often missed. Hill International has over 25 years of cost estimating experience in all types of construction.
Collection of project information will provide the data needed to make decisions about what to do with the asset. This can be the most critical and challenging part of the task. If the facility is no longer in demand in that area, perhaps it can be renovated at a reasonable cost into a different type of facility that could be more easily sold. Whatever the project, we believe that it is critical to develop an action plan now so that we are prepared to maximize the potential value of these assets as they become available.
Tags: distressed assets