Familiar Deals in Unfamiliar Contexts: Buying Retail REO Properties from Special Servicers
According to Moody’s Investor Services, the retail sector was the only asset class to record an increase in its delinquency rate for Commercial Mortgage-Backed Securities (CMBS) loans in January. Negotiating the purchase of an REO property from a Special Servicer is for many a new experience, with dimensions that don’t exist when dealing with direct lenders. When selling REO property, the Special Servicer must follow the “Servicing Standards” , such as acting in the best interest of the certificate holders, and with the same care it would use with its own property.
However, other forces weigh on the actions of the Special Servicer:
Ratings Agencies. Special Servicers themselves are rated by the ratings agencies, and how a servicer is rated affects the probability of getting hired for future CMBS deals. Proposals that to many buyers are clear win/win opportunities may look different through the lens of ratings agency criteria (see below).
Timing and Price. In addition to time constraints imposed by tax law, a Special Servicer must usually prepare a business plan projecting how long it will take to sell a specific property and how much can be recovered. Because a Special Servicer’s rating can be adversely affected if it fails to meet its business plan, it has an incentive to sell on time within its projected price range, and that may drive it to reject proposals that seem to offer a better deal.
Compensation and Advances. Generally, Special Servicers don’t share directly in the amount recovered from a sale, so their personal stake in a higher-than-projected sales price is limited.
Also the Special Servicer will usually have to advance its own funds to pay for property carrying costs, as long as it hasn’t determined that it will be unable to recover such advances from a sale. But even when the Special Servicer believes that advances are recoverable, its own financial needs may make it reluctant to continue making advances. If a non-recoverability determination has been made, speed of disposition of a property becomes paramount, because the Special Servicer will no longer advance carrying costs, so there is a near certainty that the value of the property will decline.
Information & Control. Many prospective buyers of REO property have limited access to CMBS information that would be valuable in the negotiating process. Unless a buyer is active in the CMBS world, it is not common for it to spend the thousands of dollars a month for Bloomberg terminals or Trepp accounts. But without these, it is difficult to determine which class of certificate holders is the Controlling Class and who controls that class. Since sales of REO property usually need the approval of the Controlling Class, the buyer may not know whose approval it ultimately needs.
Although barriers to entry are high, for those willing to invest the time to navigate the somewhat unique incentive structures of retail REO properties, the potential rewards are very real.