The commercial real estate industry is still managing the COVID-19 pandemic and the heavy toll it has enforced on the national economy. The National Bureau of Economic Research declared in early June the U.S. economy was officially in a recession, less than three months after government-mandated shutdowns began en masse.
Jay Olshonsky, president and CEO of New York-based NAI Global, says the sudden economic impact of the pandemic on the commercial real estate industry has already exceeded the global financial crisis.
“The immediate magnitude of this is much greater than 2009,” says Olshonsky. “Some economists are predicting this could be 20 times as bad as far as the number of properties that are affected and could potentially go into default. The numbers are pretty staggering.”
Jay Olshonsky, NAI Global
But Olshonsky is quick to point out that the current situation isn’t a doomsday scenario, nor is it permanent.
“It will slowly get back to normal,” says Olshonsky. “There are a multitude of side effects. For every sell there’s a buy, for every loss there’s an opportunity. There will be opportunities that will be created.”
Among those are distressed real estate assets, which can take the form of properties in foreclosure or mortgages that are auctioned off by the lender. With so many property owners struggling to make their mortgage payments and cover operational expenses, Olshonsky says it’s only a matter of time until the wave of distressed assets hits the market.
“If you’re three months behind on your mortgage, the question is if you can survive another three months that you don’t pay and now you’re behind by six months,” says Olshonsky. “Keep in mind, most businesses have about 27 to 30 days of liquidity. This is a question of time.”
In June, Trepp found that the CMBS delinquency rate jumped to 10.32 percent, which is a nearly 750 basis point rise from one year ago when the rate was 2.84 percent. The June delinquency rate is very close to the 10.34 percent mark in July 2012, the peak of the post-global financial crisis and the all-time highest rate on record.
The CMBS delinquency rate is an important metric to track since it’s an indicator of what properties could enter foreclosure and be seized by the lender. CMBS loans account for approximately 20 percent of total loans on commercial properties, according to Trepp.
In July 2020, the rate settled down to 9.6 percent, which is the biggest month-to-month drop in the rate in the past four years.
REBusinessOnline recently caught up with Olshonsky to discuss the timeline of events for distressed assets and how that market will ultimately help set the table for commercial real estate’s recovery. The following is an edited interview:
REBusinessOnline: The COVID-19 outbreak had an outsized effect on retail, restaurants and hotels. Do you expect the distressed assets coming to the market to consist mainly of those property types?
Olshonsky: In short, yes. Retail has gotten hit extremely hard because it was limping into the pandemic, but it’s been crushed since — stores closing, bankruptcies, vacancies, etc.
And hospitality may be worse off than retail. The sector went to zero occupancy. They’re back up somewhat, but rates are way down. Any owner that has a convention hotel is dead right now as there are no meetings or even parties.
Hotels were highly levered to begin with and now they have no income. As soon as these owners get past their 90-day deferrals, what are they going to do? Lenders are going to have to make a decision on whether they foreclose or have the owner hand over the keys.
And multifamily isn’t immune. It’s still a great investment long-term, but in certain cities with eviction moratoriums owners may be getting 50 percent of their rent paid. At some level owners can’t pay their debt service, taxes or maintenance.
REBO: Walk us through how the process will go from a struggling property now to one that will ultimately be a distressed asset.
Olshonsky: It starts with the actual owners of these properties, they have to come up with a plan.
The next step is talking to the lender about deferring their mortgage payment. The lender could be a national or regional bank or life insurance company or private equity. They at some point are going to have to follow the legal process and notify the mortgage holder that they need to pay. They might have to start the foreclosure process, not because they want to but because they have no choice. Then some owners will declare bankruptcy and they let the courts work things out.
There’s no real sign that even if it’s a sharp V-shaped recovery how those property owners can recover fast enough to get them into paying their mortgages.
REBO: What kinds of investors are getting involved to capitalize on distressed opportunities?
Olshonsky: There are enormous amounts of businesses and institutions waiting to buy at a discount. They’re raising the money and they’re ready. There are at least 10 if not 20 buyers for every potential seller.
The money on the buy side will ultimately solve the problem. At some point, banks will get tired of transacting property by property and they’ll bundle 100 loans and call someone like us that will take it to market and do a controlled auction of all those notes. Bids could range from 10 to 20 cents on the dollar to hopefully closer 70 to 80 cents. No one knows where the floor is right now, but it will be created by the private capital that’s waiting to pounce. The problem is there’s nothing to pounce on, yet.
REBO: As far as regionality, are markets that saw solid job, population and tourism growth before the pandemic any better or worse off for distressed assets?
Olshonsky: Using the New York Tri-State area (New York, New Jersey and Connecticut) as an example, this was absolutely the hardest hit area in the United States from the pandemic. The region had the most deaths and hospitalizations and the quickest shutdowns. Right now the number of hotels in trouble in New York City will far exceed the number of hotels in markets like Atlanta because of the circumstances.
REBO: How long will the rollout of distressed opportunities be available?
Olshonsky: If you look at commercial real estate sales activity the past several years, there was a noticeable gap in 2009. It wasn’t until late 2010 and 2011 where sales activity started to pick back up. If that’s a year or a year and a half where properties fit into the category of distressed, the range is probably a year and a half to two and a half years. That’s an educated guess.
The other factor is that there will be companies that don’t want to go through that whole process so they’ll decide to sell their properties for a discount. It takes a lot of expertise and time and energy to foreclose on a property. It’s also an expensive process with hiring lawyers and consultants to manage the proceedings.
Some might elect to start the process sooner, which is where the private capital comes in. We’re going to start seeing distressed assets hit the market in six months. That’s when the deferrals will stop.
REBO: What advice do you give clients looking to sell distressed properties?
Olshonsky: We advise sellers to market their distressed assets broadly to whoever is out there and is qualified to buy. There are plenty of good platforms to market that asset, whether it’s a note or an individual property. Some will elect to use online auctions, and those can be very efficient. The auction is on a set date, there are pre-qualified bidders and if you do it without reserves you know it’s going to sell.
We recommend sellers follow a process and not rely on their own network. If they have 10 meetings with potential buyers, maybe it’s the 11th buyer they didn’t meet that would’ve bought it at the highest price. Take it out to the world and it can get done in three to six weeks.
— Interview by John Nelson