| Posted by stuart on December 9, 2009 |
Purchasing Distressed Asset debt vs buying REO Real estate
Many investors, both of commercial properties and residential investors, actively seek out REO or OREO real estate assets from banks because of the value that these properties may offer. For purposes of this discussion we will only be talking about commercial real estate. While there are a number of companies that specialize in REO Real Estate, there are very few companies that specialize in Distressed Asset sales. And yet distressed asset sale represent a much greater potential value to a wider range of investors than REO real estate does for a number of reasons.
For those investors that want secured property and can or are willing to work with the existing business or property owner to resolve what may be a temporary cash flow issue, purchasing the distressed debt may be an ideal opportunity to generate excellent returns on investment. For example, let’s say a business borrowed $2 million to construct a new facility that had an appraised value of $4 million when it was completed two years ago. Now, due to the current business climate the business owner is not meeting his cash flow projections and the appraised value of the property is half of what it was or $2 million dollars. The business is still viable, still generating cash and profit, just not enough to make the original note payments.
A workout specialist firm may see this as an opportunity to purchase the note. Let’s assume in the above example the note has a remaining balance of $1.7 million and the bank is willing to sell the sub performing note for $1.3 million. The workout specialist can acquire the note for $1.3 million secured by property that appraises at $2 million. Now the workout investor can offer a temporarily reduced payment schedule to the business owner until there business improves and recapture the difference that the investor paid for the note $1.3 million to the remaining balance of $1.7 million all the while receiving payments and being fully secured!
If the workout process took three years, the recapture on the note would be $400,000 plus the interest payments that were received in the interim on the $1.3 million dollar note balance that the investor acquired. The straight ROI for the three years on the recapture would be 30%, plus they have the 8% per annum interest rate.
In the above scenario the investor, bank and business owner would all win! The bank will be able to sell a sub performing note for 76.4% of remaining balance (far better than the 20% the ‘sharks are offering), the business owner succeeds and the workout investor uses their cash, and perhaps knowledge with a business, to achieve an above average secured return on their investment.