A purchaser can secure control of an asset based on the ability to resolve issues, not the willingness to pay the highest price. In this market, that is what investing is all about.
To successfully execute high-quality opportunistic investments in this post-recession environment, it is critical to focus one’s time on the pursuit of transactions that have a high probability of closing and offer an identifiable ability to gain a competitive advantage in the sale process. To that end, many successful buyers are employing some, if not all, of the following strategies as weapons in their arsenals.
- Focus on your competitive advantages, know your competitors, and target your investments accordingly. It is not sufficient to want to own a desirable asset in a preferred location. The buyer must realistically reflect on the competition’s cost of capital, ability to close quickly, credibility, and appetite for assets of this nature. If the would-be purchaser is not a public real estate investment trust (REIT) but desires fully leased trophy assets, it should recognize that, unless it has a nimble, low-cost-of-capital partner, the probability of success is low. Accordingly, it would be far more productive to focus on complex, value-added transactions in which the highest price does not always prevail, but a purchaser’s speed, creative structuring capabilities, and willingness to underwrite and structure around complicated issues will prove to be enormously valuable.
- Search for motivated sellers and dislocation of capital. For fluid, well-financed assets, competitors continue to drive unleveraged yields down, given the availability of, and access to, affordable debt. When advance rates are low and more equity is necessary, the pricing of an investment is significantly reduced to accommodate the higher equity yields that are required. It stands to reason that an empty office building will require an all-equity purchase and should sell for pennies on the dollar, whereas a fully leased and financeable apartment community will require far less equity and sell for far more. Therefore, astute buyers seek assets for which lenders currently have little or no appetite but which will become more attractive to lenders as the market recovers.
Irrespective, buyers must still identify motivated sellers with time, capital, or resource constraints, such as a quarter-end deadline, an investment fund expiration, an illiquid and closed investment fund without access to capital, or an impending tax obligation, to name a few. Absent some compulsion, the assets will never trade. Often, clever buyers seek assets with pending capital requirements, including tenant improvements or leasing commissions, necessary mechanical upgrades, or, for hotels, brand-mandated product improvement plans. These issues, if not quickly resolved, will lower the property’s value, create an even greater sense of urgency, increase the motivation to sell, and otherwise compound and accelerate the distress.
- Avoid sellers who are not really the owner. It is an unfortunate reality, but many owners seeking to sell today simply have no equity remaining in the asset and view a sale as a final attempt to repay an overleveraged loan and perhaps avoid recourse obligations. These sales efforts are often an exercise in futility because market pricing simply is not sufficient to solve the seller’s problem. Accordingly, understanding an asset’s capitalization, and who is really in control, is critical. If an asset is overleveraged, it is wise to refrain from signing a non-circumvention agreement with the owner because this may create an obstacle to a transaction when the buyer reaches the real party in control, the lender, or, even worse, provide the owner with the leverage to demand compensation. Value-added and distressed sales in today’s market most often include the lender, so it is critical to be dealing directly with that party.
- Search for inefficiencies in size, location, or asset type. Everyone wants to own a fully leased Class A asset in midtown Manhattan. Unless the buyer is willing to overpay, it is wise to focus on assets that are below the radar of many investors—those located in strong, diversified secondary markets or that are relatively out of favor with investors and the debt markets. Two favored sweet spots are investments that require significant equity checks, thereby minimizing the pool of buyers, and investments too small for the large institutional buyer but that still require more capital than the local investor can afford. In addition, many sophisticated buyers are snapping up assets in second-tier cities, betting that in this low-yield environment, it is only a matter of time before the core market buyers lose patience and explore beyond the realm of their original business plans.
- Speak to the ultimate authority in connection with the sale, when possible. The ability to identify and diligently underwrite high-quality investment opportunities is relatively meaningless without access to the decision makers within ownership. Without such, a realistic offer has the potential to be misinterpreted or ignored. In many cases, offers are rejected by the asset manager, only later to be accepted by someone more senior. Well-intentioned brokers and asset managers often can poorly communicate a proposal, even when it is in writing, or, worse, can make a judgment about its viability, leaving the seller with a distorted view of its options. Brokers and asset managers are often motivated by different considerations than the seller, such as higher upfront cash proceeds, which translate to a higher commission; ease of documentation, which lightens the load on overworked asset managers; fear of making a mistake regarding a complicated structure; and other considerations. Savvy would-be buyers often network extensively to establish contact with the ultimate decision maker.
- Be creative and solve problems. Unless it is a REIT or otherwise backed by equity with a relatively low return requirement, a buyer in this market will have to focus on fundamentally good assets that are mired in temporary issues that can be resolved with some creativity. Temporary issues—such as overleveraged properties requiring a workout and an equity infusion, desirable properties in need of renovation, incomplete Class A developments in preferred locations, monetary franchise defaults for hotels, owners’ failures to fulfill financial or other lease obligations, and other seemingly solvable issues that may appear to have a significant impact on asset value—often reduce the pool of interested buyers and increase a purchaser’s odds of a more favorable transaction. By contemporaneously structuring multiparty resolutions and implementing other creative strategies, a purchaser can secure control of an asset based on its ability to resolve issues, not its willingness to pay the highest price. In this market, that is what investing is all about—solving problems—and there is no shortage of them today.
