In the summer of 2005, David Schechtman — then a bankruptcy lawyer at DLA Piper in New York — was in a small room in Hope Hull, Alabama, doing due diligence for a bankruptcy at 11 p.m. when he saw something that would change his career. He came across the account statement for a young real estate broker selling one of the assets. That person made three times what he made that year. A few weeks later Schechtman, quit his law firm job and applied for his first job as a real estate broker.
A decade and a half later, Schechtman is a senior broker at Meridian Capital Group, the second-largest mortgage broker in the United States. And at a moment when much of the world is watching the economy collapse with mounting fear, Schechtman sees what he first saw in that Alabama conference room: opportunity.
The collapse in the economy is expected to create a wave of foreclosures and distressed assets which will create the opportunities that investors, especially those who capitalized from previous recessions (or wish they had), have been waiting for. But some things are different this time than in the last crisis. The cause of the economic downturn was not originated by the markets and the government was much quicker to act, delaying mass distress to the fourth quarter of the year.
Millennials have seen historically high real estate prices throughout most of their careers, and for those who held onto their jobs and saved enough money, it may be the first time they’re able to buy. The mortgage market kicked off the year with record low interest rates and improved performance metrics. Serious delinquencies and new defaults were at historical lows. The housing market, heated by the low supply and attractive low interest rates, held inflated prices across the country. Finding a bargain deal seemed almost impossible before the coronavirus, now, with over 30-million jobs lost since mid-March, investors are starting to make calls.
Schechtman entered the real estate business just before the housing collapse in the last recession. He did well then, but with a larger network and more dry powder out in the market, he hopes to do even better this time.
“I sold $1.8 billion worth of distress in a 24-month period,” he says, “this time, I think I’ll double that.”
This recession, unlike the Great Recession or even the Great Depression, happened while the economy was in great shape making the timing and impact of distressed debt investing on the market quite different. The recession we are in now wasn’t caused by an economic shock or a market bubble that all of a sudden burst, it was deliberately induced to help the medical industry cope with the flood of patients infected with the novel virus. This left more people sitting on cash, which translates into more demand that in turn could hold up the price of distressed assets much higher than they would have been otherwise. In contrast, during the 2008 housing market crash, capital was scarce and distressed debt investors were getting unheard of bargains in exchange for the much-needed source of liquidity. This time, the government stepped in to fill that need faster than ever before, leaving a lot of dry powder on the sidelines. It doesn’t mean that distress won’t happen, but it delays the bulk of distressed deals.
Distressed debt investing, as the name describes, is an investment strategy used to profit by purchasing the debt of borrowers who default on their loans at a discount. In real estate, the investor is after the properties used as collateral, getting them at bargain prices.
Distress also occurs when the markets are doing well, situations such as death, divorce and bankruptcy lead to great distressed real estate investment opportunities. The difference in a recession is the magnitude. A few businesses in distress during normal times doesn’t shift regular operations, but when a bank finds itself holding too many properties at once, it needs buyers to take them off their hands quickly.
“Banks are not in the real estate business, they’re in the lending business,” said Eli Tabak, from the financing firm Bluestone Group. “The last thing a bank wants to do is own a 6 story walk up in the Bronx with 40 apartments and have HPD (Housing Preservation and Development) calling them in the middle of the night.”
“In 2007-2009 the Fed learned lessons: go in big and go in fast,” said Stan Shipley, an economist at Evercore ISI.
The Federal Reserve started slashing rates in early March in anticipation of the economic disaster that would unravel in the next few months. Also in March, Congress passed the Coronavirus Aid, Relief, and Economic Security Act — the CARES Act, which allocated trillions of dollars to programs such as small business loans and grants and federally backed mortgage relief options in order to keep the economy afloat.
“They are dumpling a lot of money to buy some time,” said Shipley, “but distress is coming, it’s just not here yet.”
Under the CARES Act, borrowers are protected from having lenders with federally backed loans foreclose their homes until at least June 30th, 2020. After that, the borrower has the right to request an additional forbearance for up to 180 days. This means that the bulk of foreclosures, at least for homes won’t come up until the start of 2021. Retail and other commercial assets will start falling sooner.
Finding distressed real estate deals is only the start, the due diligence that follows is just as important. As opposed to regular real estate transactions, distress involves more risk. Court proceedings can stretch from months to years which is why underwriting the litigation risk is essential. Similarly, value assessment requires skill, the price of a property may seem like a bargain today, but what will it be worth in the future?
Retail properties were already losing their value with the rise of online shopping, and after COVID-19, they may never bounce back. Experts expect that other commercial properties, such as hotels, will recover their value in the long run, even if the current companies running them today go bankrupt this year.
“I think the first to file will be the small mom and pop retailers,” said Richard Maltz, CEO at Maltz Auctions. “I think I’m going to be changing locks on five locations a day if not more.”
Schechtman is one of millions of brokers already working with banks on distressed real estate deals nationwide. While risky, he considers them to be a natural part of the market’s cycle not a ‘vulture’ or ‘opportunistic’ move. “If you were to tell me somebody’s losing their apartment it’s one thing, but we’re dealing with people who invested millions of dollars,” Schechtman said. “They’re sophisticated people. It’s big boys and girls who are rolling the dice.”
Large commercial investors are not the only ones who will find themselves in distress in the foreseeable future. Real estate in all asset classes will lose value and eventually many homeowners will also become distressed.
“So get a good broker to bring you opportunities, get a good lawyer who has seen this movie before,” said Schechtman, “because this is not for the weak of heart, it really isn’t.”