Distressed Real Estate is Capturing the Attention of Investors

Earlier this year, The Wall Street Journal reported that a sometimes-overlooked asset class — distressed commercial real estate — appeared to be capturing the attention of institutional investors.

The piece — “Cash-Flush Buyers Dip Into Distressed Commercial Real Estate”  — reminded readers that, while many commercial properties experienced a post-pandemic lull, some investors who are flush with cash are seeing opportunities where others only see empty buildings. “Many … investors have been stockpiling funds since early in the pandemic,” according to The WSJ. “They have been frustrated because most property owners haven’t agreed to sell at big-enough markdowns, in large part because lenders have been willing to offer loan extensions and modifications.”

But that appears to be changing. The post-Covid business landscape is forcing many lenders to pressure distressed commercial property owners to rethink their plans to hold onto properties that are empty due to work-from-home policies. And the pressure isn’t limited to empty offices. “[Lenders] are getting tougher on hotel owners who have neglected repairs [and] they are calling in loans to apartment-building owners who fell behind on construction schedules owing to supply-chain shortages,” according to The WSJ.

Current interest rates have only intensified this pressure. Property owners who agreed to adjustable rate loans pre-2022 are now feeling a pinch due to high rates. And where once local banks might offer extensions on the loans, The WSJ reports that is no longer an option because bank regulators frown on lenders carrying too much real estate exposure.

That’s where well-heeled investors come in. Many are now in a position to rescue these distressed property owners. The WSJ article includes mention of one investment firm that spent more than $600 million on several under-occupied, multi-family properties located in West Palm Beach, Florida. It is understandable why investors might take a favorable view of Palm Beach opportunities; as I recently wrote, growth in the Palm Beach area is booming.

Others have also taken note of investment in the area. In late 2023, Commercial Observer, a real estate media company, wrote that “for all of Florida’s strengths, there is no escaping the fact that almost $1.5 trillion in commercial real estate debt comes due by the end of 2025. For the time being, distressed properties are hard to come by in Florida, but that may change as pressure mounts on owners whose assets currently benefit from low financing costs.”

*Note: the $1.5 trillion commercial real estate debt mentioned above isn’t exclusive to Florida; it’s a nationwide figure.

Why should investors take a chance on distressed properties?

Distressed real estate can be an attractive alternative for investors because those properties are usually listed well below market rates. This can be more appealing if the properties are located in areas where real estate prices are strong. And, in some cases, lenders may even be incentivized to offer prospective buyers attractive interest rates if it means they can get vacant or dilapidated real estate off their books. And there are plenty of opportunities to go around. As of January 2024, the pool of distressed commercial real estate in the U.S. was valued at nearly 86 billion dollars.

If investors continue to be on the lookout for attractively priced commercial real estate, it may mean good news for the economy. As The Wall Street Journal noted last February, a bump in sales could “help stabilize the commercial-property market at a time when sales volume has plummeted owing to higher borrowing rates, and weaker cash flows for some property types.” Only time will tell if this trend continues, but if it does, it may capture the attention of additional investors seeking undervalued opportunities.

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