COVER STORY, MARCH 2010

TURN DISTRESS INTO OPPORTUNITY
Savvy buyers can find deep discounts in distressed assets.
Gil Y. Burstiner and Will L. Lovell

The FDIC has played a large role in this recession by taking control of failing banks. Last year, the FDIC took over in excess of 130 banks, and in January alone, it shut down at least nine banks. Generally, the FDIC then initiates a competitive bidding process and sells each bank’s assets to the highest bidder with strings attached. For example, State Bank and Trust Company in Macon, Georgia, acquired the assets of The Buckhead Community Bank and First Security National Bank from the FDIC in December. Along with the purchase, the FDIC and State Bank entered into a loss-sharing agreement whereby the FDIC agreed to cover approximately 80 percent of State Bank’s losses. The FDIC also will receive a portion of State Bank’s profits deriving from the sales of the assets within a certain time period, so that State Bank would be incentivized to buy, and then promptly dispose of, the assets. This loss-sharing agreement permits the FDIC to manage its insurance fund money while allowing the assets to be disposed of quickly in the private sector.

During these troubling times, the expression “one man’s loss is another man’s gain” has never been more true. These acquisitions have proven to be incredible opportunities for well-positioned real estate companies to purchase properties at extremely low prices. Companies are presented with a dream situation: they can negotiate with sellers who are incentivized to aggressively sell their distressed assets, which consist predominantly of REO and under-performing loans, at below par value. Furthermore, at a time when securing financing is difficult, the purchaser may find that the selling bank will finance the sale as well. At this time, many of these assets have been residential, but the commercial sector is now heating up. Unfortunately, even savvy real estate professionals find themselves in trouble when they do not facilitate these transactions with caution. Therefore, before purchasing these assets, it’s imperative that a company understand and appreciate the risks prevalent in these transactions.

During the boom time, many of these now troubled banks were more worried about getting loans out the door than fully understanding what was securing the loans. As a result, poor title work was conducted on properties, and the loan documentation is often incomplete. To avoid these pitfalls, a real estate company must hire a good lawyer and title company to conduct an analysis to identify and correct any such problems prior to purchase and to help guide them through these cumbersome transactions.

If allowed by the bank, the purchaser should talk to the borrower to get information about the property. This enables the purchaser to effectively evaluate all options. For example, if the purchaser seeks to acquire a note in default, they need to know whether its plans for the property coincide with that of the borrower’s. If the purchaser wants to control the property and the borrower wants to walk away, then the purchaser may strike an agreement with the borrower. The purchaser would foreclose on the property and not to seek a confirmation action and pursue the borrower and/or guarantor personally beyond borrower’s interest in the property.  If the borrower wants to stay involved with the property, the purchaser has limited options: it can initiate the foreclosure process, which the borrower may try to fight, or the purchaser may create a joint venture with the borrower. A purchaser should also consider the likelihood of the borrower filing for bankruptcy, as this could tie the property up in bankruptcy for an extended period of time.

As an alternative to the above scenarios, a company must understand and analyze the risks involved in taking a deed-in-lieu of foreclosure from the borrower. While a quick and inexpensive way for the purchaser to take full control of the property, a deed-in-lieu will not extinguish any existing liens or encumbrances. It could also expose the purchaser to significant liability. Notably, if there is a junior loan on the property, the purchaser would then be liable for the payment.  Accordingly, substantial due diligence must be conducted before taking a deed-in-lieu and thought must be given to how to mitigate liability. 

Certainly, the pace of bank failures will continue in 2010, and savvy real estate investors poise themselves to capitalize on the opportunities provided. If a purchaser is able to avoid or at least substantially mitigate risks, it may find itself owning property at far less than the property’s original cost.

Gil Y. Burstiner and Will L. Lovell are with Atlanta-based Hartman, Simons & Wood, LLP.

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