COVER STORY, MAY 2009

DISTRESS CALL
A look at receivers, and their role in distressed property disposition.
Kevin Jeselnik

As the dust continues to settle from this generation’s worst economic collapse and the U.S. government sets out to repair its financial market in the midst of economic uncertainty, there are more questions than answers. In the commercial real estate industry, the following 24 to 36 months will find a number of CMBS loans maturing for properties that are not performing at the level anticipated when the borrower took ownership and may already have material challenges. The risk of loan defaults (monetary and maturity) on these distressed assets is of the utmost concern for many owners, lenders and tenants. So far, the majority of lenders have sought alternatives to foreclosure when working with borrowers to resolve delinquencies and defaults. However, the time may come when property ownership reverts to the lending institution. Heartland Real Estate Business has spoken with a collection Midwest-based industry experts about many facets of this process, including court-appointed receivership, foreclosure auctions and the buying opportunities available to investors in these trying times.

Dozens of companies now offer specialized services to clients for dealing with distressed assets. Rosemont, Illinois-based Foresite Realty Partners began operations in 2005 with the expectation that many of these challenges with special assets would materialize in the near future.

Foresite CEO Donald Shapiro, after living through three previous recessions since the 1980s during his time in the industry, dedicated one arm of the company to handling a variety of distressed situations, with a specialty in state and federal court-appointed receiverships. Foresite’s complementary platforms — offering third-party services across 14 states in the Midwest, which includes its focus on “properties in transition,” and its principal investment acquisition fund — provide the company with balance, but its work on properties in foreclosure, default, bankruptcy, REO and receivership currently comprises the majority of its business. Shapiro currently has more than 50 court-appointed receiverships in eights states under his or other’s control at Foresite.

Shapiro has approximately 25 years of experience in real estate, with significant hands-on work with underperforming, non-performing and distressed assets, so he feels Foresite has the historical knowledge and capabilities to best reposition the properties in transition. When a default exists in the loan and the lender believes there is a sponsorship problem, unacceptable negative change in the physical condition of the asset, or the market deteriorates in such a fashion that a control in the asset is needed, then the lender historically requests the court to appoint an independent third-party (the receiver) to take over the day-to-day duties of the property. Now, mortgage foreclosure acts in many states give lenders the right to request a specific receiver, so it pays to have a toehold in the practice. A receiver needs to have a broad swath of knowledge about many facets and disciplines of the real estate industry, which include but are not limited to asset/property management, leasing, brokerage, investment sales, operations/accounting, development/construction supervision, as well as a strong understanding of the pertinent statutes in each state (or federal law) dealing with the responsibilities of a receiver.

“Generally, the responsibilities involve preserving, maintaining and creating value in a property,” Shapiro says. “From the beginning, you begin to put together a picture of what is going on at the property by securing as much information as possible and then analyzing it to understand what has happened historically and put in place a strategic plan to improve the conditions of the property.”

“The initial goal is to preserve the in-place asset, make sure to maintain NOI where it is, and then really analyze the financial condition of the property, to see where the opportunities are, make sure rent rolls are accurate, and really prepare the asset for disposition,” says Mark Parten, senior vice president of property management for Minneapolis-based Welsh Companies.

Welsh Companies has a long history of receivership and foreclosure work in the Minnesota market, and has leveraged that experience to serve those clients that currently find themselves in such a situation. Welsh has formed the Special Asset Services group to provide solutions to owners and lenders dealing with distressed properties.

“We have pulled together a group of industry professionals from all of Welsh’s products and departmental lines to assist our clients, specifically receivership, REOs, bank-owned properties, vacancy challenges and disposition issues,” Parten explains.

In the last 25 years, Welsh has managed more than 100 assets, totaling more than 10 million square feet, in receivership assignments. The company currently has in excess of 2 million square feet in receivership and bank-owned assets. Welsh’s focus when taking control of a foreclosed property is on management of the asset. Everyone agrees that, first and foremost, the receiver must get a handle on the cash. From the current balance in the bank to the rent due, the property’s books are the first object pored over by a receiver.

“We have to find out if there are any major accounts receivable issues, tenants without leases, cash in the bank, safety and code violations before we move forward,” Shapiro says.

According to Shapiro and Parten, other significant steps taken by receivers to stabilize distressed assets include:

• Ensuring that the asset has the proper insurance: In many cases, insurance has lapsed or no coverage exists, so the receiver must secure liability and property insurance, and make sure that said coverage is consistent with the loan documents. Receivers often have pre-existing relationships in place that allow them to solicit bids in order to find the most cost-efficient coverage, with few termination fees or short-rate penalties involved.

• Assess where the property is from a real estate tax standpoint: How is the property assessed? When was the last time the taxes were appealed? The receiver should ask these questions, and make sure the taxes are up to date, or if a foreclosure sale is imminent. Then, notifying the courts and both the plaintiff and the defendant as to the status of the taxes and deciding which entity will pay them, especially if there is insufficient cash at the property to pay.

• Modifying or changing utility accounts: A seemingly minor, but key, issue in such properties, in that the receiver takes on responsibility (not personally) for these accounts the day it is put in place. A receiver can also look at the existing contracts to make sure that the property is getting the best pricing and services for the tenants and occupants of the property, and can terminate contracts not favorable to the property. As Parten notes, “There are always ways we can enhance the services and still improve the bottom line through our industry buying power.”

• Leases and tenant relationships: Receivers must communicate with tenants to let them know a responsible third-party is taking control, as well as they are accurately recording and collecting all rents and looking at the leases to make sure no rent steps were missed and that escalations are property calculated.

• Addressing physical deficiencies: Welsh always seeks to address some obvious areas of the property, whether from an aesthetic standpoint or if it is deferred maintenance. Dealing with small issues like this ensures that they do not become roadblocks in a potential sale of the property in the future.

There are myriad challenges waiting to be confronted when a receiver assumes control of an asset. Foresite attacks the task from the onset with a 16-page detailed court order that it produces for each property it takes over.

“We write our own court orders because it is much easier to have that information included in a black-and-white piece of paper than to refer to the state’s many statutes,” Shapiro explains. “We put a lot of language in it that is black-and-white, so everyone understands what our responsibilities and duties are, and the boundaries of our authority to take action. If something comes up that is outside of that authority, then we go to the court and seek its approval.”

Both Shapiro and Parten expect the Midwest to continue to need receivership, REO and bank-owned expertise over the next 2 to 3 years.

“That need will increase as the banks determine that their strategy will be to get these assets off of their books, write it down, re-value the assets and go through the disposition process,” Parten says. “In order for the market to turn around, we need to get this real estate off of the banks’ books.”

“In the short-term, our third-party services arm will continue to grow, but I think there will be more creativity in the marketplace in order to value-engineer the process and find better ways to improve an owner’s situation,” Shapiro says. “One thing is certain: this marketplace is the best training ground to get a well-versed, diversified and flexible education about the good, bad and ugly of real estate. I’ve learned more in down markets than in any up market.”

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