Will Banks Be Long-Term Owners?
I have read some speculation lately that even in the wake of a heavy stream of commercial property foreclosure activity, many believe that banks will not be in any hurry to sell these assets. Why? Because they will not be willing to take the losses necessary to move the properties. The speculation is that banks will ramp up property and asset management functions both in-house and out in order to stabilize the assets and capitalize on improved market conditions.
If this is the case, expect sale transaction activity to drop to near zero. If there are no distressed asset sales, only the single-tenant market and top quality assets will be trading and there are only a finite amount of each available at any one time. The timeframe necessary for repositioning and stabilizing these failed properties varies greatly from asset to asset but it is generally not quick. Stabilization will require rents to stop their downward spiral and occupancy to begin to increase (tenant demand). Both of these trends will be supported by consumer demand and spending – neither of which look to be turning around anytime soon. Expanding tenants will have the pick of the litter as far as location options go and landlords will be fiercely competing for any active tenant in the market, giving tenants a significant negotiating advantage for some time to come.
Just how long will banks want to own these properties in order to recover their cash? Executing a repositioning strategy over numerous properties will be very difficult for the most experienced owners, much less for an institution whose primary business is not real estate ownership. Banks will need to hire the expertise which will mean increased labor costs. They will also need to reinvest in the properties in order to reposition them. For some reason the prospect of a bank spending $50 PSF to rehab and re-tenant a property does not seem likely to me. That is the kind of risk that investors take and that is why they take the equity position. Banks are conservative (compared to investors) and take the sure thing (interest payments) as opposed to the upside. Clearly, there will be money to be made in repositioning these foreclosed properties. That is the reason why investors are lining up on the sidelines waiting to pounce on the opportunities. The banks may know that the path to the money is in their hands but its just not what they do. How many times have you seen someone who owns a property say it could be this or that but you know they can’t make it happen and then they finally sell the property and the next guy executes on what everyone knew could happen. Its not luck. Knowledge, skill set, stamina and risk tolerance have a lot to do with the outcome of any project. I just don’t see the banks as the next group of turnaround specialists.
Even though the reward may outweigh the risk, banks will have to adopt a whole new business plan to effectively own and manage large portfolios of commercial property. I think these banks will be better off focusing on rebuilding their core businesses rather than throw good money after bad all the while learning to operate a whole new business. That sounds like a recipe for more failure.
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- CRE Takeaways From Bill Gross’ Investment Outlook
Good post Chris. I agree with you – on the surface holding looks like a good strategy, but lenders typically way underestimate the headaches of ownership, and once they experience them they get rid of their REO and go back to lending.
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