Exploring Distress Investing in the Current Real Estate Market
In a recent episode of America’s Commercial Real Estate Show, the show host and guest Joe Sarachek, a managing partner of the Sarachek Law Firm, author of Distress Investing Playbook, and Adjunct Professor at NYU, explored the world of distressed commercial real estate investing. The conversation centered on the current state of the market, key strategies for investing in distressed properties, and the nuances of due diligence in this high-stakes field.
Interest Rates and Market Conditions Fueling Distress
The discussion opened with an analysis of how rapid interest rate hikes by the Federal Reserve have impacted the economy and, by extension, the commercial real estate sector. As borrowing becomes more expensive, some property owners are struggling to service their debts, creating opportunities for distressed investors to acquire properties at a discount. Sarachek noted that while opportunities for distressed investing seem to loom on the horizon, there is a prevailing sentiment among investors that the market’s most significant distress phase is yet to come.
Location-Specific Factors Contributing to Distress
The podcast touched on specific urban areas experiencing elevated levels of distress, such as New York City’s multifamily market, which has been hit hard by unique regulations and high property taxes. These factors have created conditions where many properties are underwater relative to their loan values. Sarachek mentioned that New York City judges are overloaded with real estate bankruptcy cases, especially in outer boroughs. On the West Coast, San Francisco faces its own set of challenges, with both markets presenting different kinds of opportunities and risks for distressed investors.
Key Principles for Successful Distress Investing
Sarachek highlighted the importance of careful consideration when entering the distressed real estate market, especially in terms of understanding market cycles, timing, and strategy. He emphasized that, in distressed investing, “it’s all in the buy.” Investors must evaluate potential exits and ensure the property is acquired at a price that offers the potential for substantial returns, typically targeting a 30% or higher ROI within a relatively short time frame.
He also underscored the critical distinction between active and passive investors. Active investors seek hands-on involvement, often overseeing property management and asset improvements, while passive investors prefer to partner with reliable operators who handle the day-to-day operations. For those less experienced or without local knowledge, passive investing may be a safer route.
Sourcing Distressed Properties
When it comes to finding distressed investment opportunities, Sarachek encouraged investors to leverage their personal expertise. Whether one has specialized knowledge in hospitality, healthcare, or retail, understanding an industry provides a competitive edge in spotting underpriced or mismanaged properties. The host added that partnering with knowledgeable brokers can provide access to valuable resources and insight into viable distressed properties.
The Importance of Due Diligence
Sarachek emphasized that due diligence is crucial when purchasing distressed assets, particularly when acquiring notes rather than physical properties. Evaluating these notes requires a deep dive into property histories, tenant quality, and the legal framework. Experienced investors look at every document and consider various potential obstacles, such as liens, code violations, and management issues.
The conversation included a real-world example involving a note purchase on a popular wedding venue in New York. Despite initially appearing as an attractive distressed asset, the venue’s owner was entrenched in complex litigation, significantly complicating the acquisition process. Sarachek’s story illustrates the need for thorough due diligence before any investment, as not all deals lead to ownership or immediate returns.
The Role of Legal and Advisory Support
For those entering distressed markets, building a solid team of brokers, legal advisors, and other professionals is essential. Sarachek emphasized that legal complexities in distressed properties can range from state-specific foreclosure laws to bankruptcy proceedings, each of which has implications for recovery timelines and final ownership outcomes. Having advisors who understand both the market and legal landscape can help investors avoid costly mistakes.
Final Thoughts
The episode concluded with a reminder that distressed investing offers unique opportunities for those willing to navigate its complexities, but it is not without significant risk. With interest rates potentially stabilizing and distressed properties presenting opportunities in key urban markets, the time may be right for some investors to start exploring this investment strategy.
As the conversation underscored, knowledge, patience, and professional support are indispensable for navigating the distressed real estate market successfully. Whether an investor’s goal is property acquisition or note-buying, understanding the underlying challenges—and being prepared to face them—will ultimately determine success in this specialized area of real estate.