Nowadays everyone is looking to buy bank notes /mortgage loans at significant discounts. They aspire to walk away with control over a prime asset in New York City for 50% to 60% cents on the dollar. However the reality is that in New York City 70% to 80% discount on a bank note IS a significant discount. What might be prevalent in other parts of the country does not reflect the circumstances, benefits and competition of the New York City commercial market.
The Status of Non-Performing Notes Market
New York City
In the course of the next four years, $1.4 trillion dollars in commercial real estate loans are expected to come due. Moreover, contrary to popular perception, it is not the large banks (the Wells Fargo and Banks of Amercia) that are confronted with this looming crisis but the smaller- regional banks-like New York Community Bank. These banks loaned exorbitant amounts of money, inclusive of their reserves, to over-leveraged purchases. Consequently the rates of defaults in these regional banks predictably will continue to skyrocket. As a startingly example, New York Community Bank has 94% of its debt in the commercial real estate market! (Multifamily Investor).
Nationwide
Although the commercial real estate market is improving with prices increasing up to 6%, the rate of defaults continues its upward climb. (Realtor. org) . According to Fitch Ratings (an international ratings agency which provides bond ratings and research on banks ) loan defaults will continue to deteriorate for commercial mortgage-backed securities (CMBS). It projects the default rate to reach 11% from the current 7% by year end 2010. Among the biggest concerns are the default rates in large loans. In 2009, 56 loans in amounts exceeding $50 million dollars defaulted. Additionally, in contrast to the past five years, the retail sector with 32.3% default rate beat out the multifamily sector which experienced a 22.1% default rate. The office sector had a 20.2% default rate and hotel sector suffered a 17.8% default rate. “Fitch predicts the 10-year cumulative default rates on 2007 Fitch-rated CMBS to reach a staggering 27 percent!” (DSnews.com)
The Realities of the Purchase Process
With assurances that the non-performing notes market will continue to expand both in volume and magnitude, an interested investor needs to consider the factors at play in oder to profit from the opportunities this market has to offer.
The Research on the Property Securing the Bank Note
Unlike a traditional property purchase, in a bank note transaction there is no set-up or detailed financials to review while considering an offer. Rather the investor will only receive the address of the property from the bank. From that point on, it is the investor’s responsibility to undertake as much research as possible on the property securing the Note in order to make an informed decision to pursue its purchase. Moreover, communication with the current owner/titleholder of the property is frequently ill-advisable. The owner is in the midst of defending a foreclosure lawsuit by the bank and thus her own wish is to sell the property at top price so that she can pay off the Note herself and walk away with the equity she was promised when she purchased the property in 2007! Additionally, if the investor does in fact purchase the Note, he risks loosing negotiating leverage with the owner, if he tries to work out a pre-Note purchase surrender of title.
The Valuation Process to Formulate a Competitive But Advantageous Offer
This factor is a corollary of the previous one. In order to be able to submit a competitive but advantageous offer, an investor will be required to price in all the risk factors involved in his journey to acquire title of the property. Such risk factors include: (1) the interior condition of the property; (2) the price to persuade the current property owner to surrender title; (3) the price to persuade a tenant to seek out other living accommodations and (4) the legal fees that might be involved in bringing a foreclosure suit against the current owner.
The Negotiation Process With the Bank’s Contact
Typically a bank note deal can only be offered by a broker with a relationship with the bank. It is via this relationship that the broker is able to gain access to these Notes. The relationship between this broker and the bank is the key to negotiating a successful bank Note transaction. Since the banks are presumptively taking a loss on the sale of the Notes, they do not compensate the broker for his services. Rather, in this scenario it is the investor who stands to gain most in the deal and thus the responsibility of paying the broker’s fee validly rests upon buyer.
The Negotiation with the Owner (Title-Holder)
Upon the successful purchase of the bank Note, the investor then needs to address acquiring legal title from the current owner. The bank will inform the current owner in writing about the consummated sale and transfer of the Note to the investor. At this point the investor needs to initiate negotiations with the owner to surrender title in lieu of fighting it out in a foreclosure proceeding. Given the leverage that the investor has with possession of the Note; and disadvantages to the current owner of being flagged with a foreclosure judgment, negotiations may be heated but should prove successful.
The Negotiation with A Tenant
Similar to negotiating with a “distressed owner” in a bank note context, negotiating with a tenant may prove challenging. Often owners that default on their loans have also defaulted on other financial obligations and may have refrained from maintaining the property as a result. This situation might assist in negotiating with the tenant to seek out other accommodations.
Conclusion
As is the case with any great opportunity in life, the journey is filled with challenges. To offer you these bank note opportunities, we have partnered with brokers direct to regional banks within the NY Metro area. More importantly, to navigate the challenges from identifying the opportunities to your acquisition of the property, we also provide the professional services to support your investment objectives and lead you to a successful transaction. Should you be interested in learning more, please subscribe to our Newsletter.
