Publications & Resources

January/February 2010
Managing Troubled Assets

Disposition Strategies for REO or Distressed Subdivision Assets

By Michael J. Hixson

The Challenge

During this most unprecedented period in the real estate construction and development industry, some of the most pressing decisions that lenders, equity partners and developers alike face involve disposition strategies of non-performing residential project assets. By examining each asset by category, there is usually a “best practice” strategy that will serve to balance the often opposing goals of achieving maximum revenues while minimizing holding timeframes.

In the complex world of residential real estate development, lenders who have taken ownership and possession of these assets are generally ill-prepared to deal with the myriad of issues that surround newly-constructed for-sale real estate products, which often include such items as current value analyses, compliance with state real estate regulations, construction and completion operations, special contract provisions with home buyers, regulated warranty procedures and statutes, just to name a few. Often, the strategies essentially involve simply finding a “bulk buyer” at a tremendous discount in order to avoid dealing with these complexities, while walking away from any upside disposition revenues that may have been available by completing some construction and selling “retail” to end users.

Fortunately in this case, in conjunction with the dramatic reduction of activity in homebuilding over the past few years, teams of consultants with years – often decades – of experience have emerged as a valuable resources for overwhelmed owners of these properties to assist in obtaining the highest revenue returns possible under current market conditions, while recognizing the urgency of disposing of these assets.

Solutions

Typical classes of these types of assets require different solutions:

Raw or partially-improved land: These assets are generally only interesting to longer term investors, willing to buy and hold for periods of two or more years. Today’s negative residual values for raw land in many outlying areas precludes development and end-user sales in most situations, although higher demand in closer-in areas does provide an opportunity for developer/builders if priced correctly. Solution: Analyze and identify the target market for the asset: investor or developer/builder, price accordingly, and list with land broker, while possibly pursuing further entitlements as a means to add value.

Finished lots: Often, these assets will be highly-prized by developer/builders, in that this “recycled” land can be priced after equity write downs at a point that will allow a merchant builder to construct and sell at a profit in today’s environment. Solution: Identify end-user values specific to this asset, conduct a value analysis based on home buyer expectations and demand, price asset accordingly for purchase by merchant homebuilder, and list with land broker.

Partially-completed and finished homes: Often combined with assets from the above categories, the asset may consist of model homes and inventory in various stages of construction. Clearly, and again if priced appropriately, the maximum revenues will be derived from selling finished homes at retail, and generally any costs to complete, insure and service these homes will be far less than the increase in revenues to be gained from taking this approach. Solution: Conduct property condition investigation, cost-to-complete studies, analyze current retail values, engage appropriate team to create and execute strategy.

The above discussion centers on the more typical single-family detached or lower-density attached subdivisions that are most typical in the western US. A special case can be made for higher-density, more vertical condominium projects that are constructed in a mid- or high-rise configuration. While these can be thought of simply as “vertical subdivisions,” special construction and marketing expertise is required to dispose of these assets, and the owner should be sensitive to hiring consultants with proper experiential background.

The Consulting Team

The expertise and skill sets required to obtain maximum revenues for the lender-owner is very similar to what a homebuilding firm’s needs are in developing, constructing, and selling its products. At minimum, the following consultants with production-development experience should be engaged, generally as a team, to accomplish the goals outlined above, and all should have experience in dealing with REO and asset-management situations (each may offer multiple disciplines):

Property condition analysis
Project and construction management, including entitlement
Subdivision and transactional attorney
Liability Insurance professional (if not self-insured)
Valuation research, sales brokerage and marketing
Warranty and customer service for completed products

In Summary

Maximum revenues will always come from selling to end users, which requires a level of expertise in homebuilding issues that lenders typically do not have internally. Rather than assuming that a bulk sale is the only alternative, owners of these assets should be able to hire trusted consultants to analyze and execute those strategies that will produce the highest return for the institution.

Michael J. Hixson, MIRM is executive vice president and partner with CADO Real Estate Group, Inc. He can be reached at (858)753-1947 or m.hixson@CADOrealestate.com.