By Ralph Serrano
Every phase of the business cycle presents opportunity for investors in distressed real estate assets, provided you know where to look.
Knowing where to look and knowing how to seize opportunity are two different things, of course. Most individual, high net worth investors seeking exposure to distressed residential or commercial real estate assets lack the time and expertise to find, evaluate, close, manage, and exit such assets on their own. Most family offices face similar challenges.
The right partner — generally, a private equity fund raised specifically to invest in distressed real estate assets and debt — does have that time and expertise.
The following criteria for an ideal investment partner apply specifically to private equity shops selling interests in real estate funds, but most can be modified for partnerships and joint ventures between two or more individuals or entities. All these characteristics assume limited expertise on your part — that’s why you’re seeking an expert partner, after all.
Extensive Local Market Knowledge
Every real estate market is different. All else being equal, you want to work with a partner that knows cold the market or markets in which they invest. Ideally, your partner will have multi-cycle experience in each market, such that they’re personally familiar with the ebbs and flows of on-the-ground sentiment, deal flow, and subsector activity.
Long Relationships With Sellers and Holders of Distressed Assets and Debt
Local market knowledge isn’t solely about recognizing risks and opportunities before they become plain. It’s also about relationships — specifically, with local sellers and holders of distressed assets and debt. Depending on the nature of the assets and debt instruments in which you’re investing, these individuals and entities might include:
- Local mortgage lenders, including smaller banks and credit unions that may be all but invisible to institutional investors and out-of-market boutiques
- Local and national loan servicers
- Private investors holding distressed and performing real estate debt
- Local real estate brokers with forward-looking visibility into non-public opportunities
Knowledge of (and Willingness To Exploit) Persistent Market Inefficiencies
Local market knowledge has a third benefit: visibility into — and willingness to exploit — persistent market inefficiencies. For instance, in metropolitan markets with elevated delinquency and foreclosure rates, lenders’ workout backlogs grow faster than they’re able (or willing) to scale up their workout departments. Rather than add staff to clear these backlogs faster, they look to offload their non-performing loans, often at steep discounts.
Nimble investors that are able and willing to work out individual non-performing loans are all too happy to take on the attendant risk. In the end, they’re judged by their ability to identify acceptable risks and shepherd each instrument or pool to an acceptable exit, but their willingness to do what lenders won’t is a crucial first step.
Appetite for Single-Note and Small Pool Purchases
For a variety of reasons, most institutional investors have limited appetite for smaller loans and loan pools. Many simply draw a line at $20 million and throw out everything under, no matter how promising it appears on paper. Their quotas are simply too high, and their resources spread too thin, to bother.
If you’re looking for a boutique real estate investing partner, chances are good you won’t have this problem. But you’ll want to make sure your partner targets smaller purchases across a suitable range of categories, including single-family residential (jumbo loans, most likely), warehouse, and Class B and C office.
Conservative Asset Valuation and Risk Modeling Practices
It goes without saying that any real estate investor must follow commonly accepted valuation protocols and adhere to tolerance-appropriate risk modeling practices. If it becomes clear that that’s not the case, take a pass.
Ultimately, your own risk tolerance will guide you here, but do give careful consideration to how prospective partners value acquisition targets. A conservative approach may well pay off down the road.
Exposure to High-potential Metropolitan Markets and Submarkets
You’re already aware that diversification is key to any sound investing strategy, and your distressed real estate asset and debt portfolio is no doubt only one component of a diversified portfolio.
Diversification is important within your distressed real estate portfolio, too.
“In addition to a suitable variety of instrument and collateral types, you’ll want to work with a partner capable of achieving some measure of geographical diversity — whether via exposure to multiple metropolitan markets, or to multiple submarkets within larger metro markets.” — Ralph Serrano
Proprietary Loan Servicing Capabilities
Look for a real estate investing partner capable of handling as much as possible in-house. A high-touch in-house loan servicing platform is particularly effective for shorter-term investments that require constant attention. Don’t be afraid to look under the hood.
Ability and Willingness To Pursue a Variety of Exit Strategies
Just as a diversified investment portfolio requires a range of asset types, a diversified exit strategy requires a range of potential exits. In the world of real estate investing, these non-mutually-exclusive exit types include:
- Successful workouts (refinancing)
- Foreclosure and liquidation
- Foreclosure and payoff (auction)
- Debt restructuring
- Property sale
Demonstrated Ability To Deliver Returns Throughout the Business Cycle
The ideal real estate investing partner has a clear track record of delivering returns throughout the business cycle. As the old saying goes, it’s easy to make money when the market is going up; it’s the tough times that separate the great ones from everyone else.
Meticulous, Uncompromising Due Diligence Protocols
This is the among the most important characteristics your prospective real estate investing partner can have. Without meticulous due diligence, everything else goes out the window.
Investment Time Horizons That Align With Your Goals
Before agreeing to work with a prospective partner, make sure their investment time horizons align with your own goals. Some real estate investors target relatively tight turnarounds; others buy and hold for cash flow purposes; others pursue a mix of both, or target a variety of timeframes. Your own cash flow needs and investing goals will likely determine your preference here.
Minimum Investment Criteria With Your Resources and Diversification Goals
Last but not least, make sure you’re able to make an investment you’re comfortable with given your financial position and portfolio diversification goals. This should be easy to determine in consultation with your financial advisor and your prospective partners, and will be clearly indicated on any offering document you’re asked to review.
Are you seeking a real estate investing partner? What quality do you value most?
Safe Harbor Equity founder Ralph Serrano lives in Miami, Florida, with his family.