The COVID-19 crisis is triggering major questions about the value of assets in just about every sector of real estate.

Take a newly built student-housing complex near the campus of a state university. The appraised value of that building was derived from the pre-pandemic assumption that it would be part of a fully functional college town—a place where students would be crowding into classrooms, sports venues, bars, restaurants and the like for most of the year.

How do you put a number on the value of that building in a world of social-distancing and draconian capacity restrictions or outright shutdowns? Lenders face similar conundrums with respect to the value of certain malls, office buildings, hotels, movie theaters and the like.

Adding urgency to the situation: the rising tide of commercial mortgage defaults, bankruptcies and foreclosures – a trend likely to accelerate for the foreseeable future.

The challenges and uncertainties of today clearly are significant. However, there is a way for lenders to gain a remarkable degree of pricing transparency: engaging in a structured sale process.

Whether conducted in or out of court, structured sales can be an effective workout solution. They offer lenders protections that are particularly important in today’s volatile real estate marketplace.

Continuing Demand for Real Estate Assets
With respect to the recovery, another factor that bodes well for secured creditors is the strong demand for certain distressed real estate assets, both in and out of court. The Blackstone Group, Starwood Capital Group and others reportedly have raised hundreds of billions of dollars in “dry powder” for opportunistic acquisitions, and plenty of smaller investors are scouting for deals as well. These transactions, when they occur in a structured process, are competitive whether in or out of bankruptcy court.

Part of the reason: Bidders agree to the sale terms (including due diligence items like rent rolls, environmental reports, preliminary title commitments and management agreements) up front, as opposed to post-contract. Especially in a time of uncertainty, handling due diligence in this way gives bidders a higher degree of confidence; it’s a step that bolsters the likelihood of achieving maximum pricing.

The level playing field among bidders (they have all agreed to the same terms as set forth by the seller) accelerates the process, which otherwise could grind to a halt over terms down the line. Generally, structured sales result in all-cash offers within 60 to 75 days. While they give sellers control over the process and timing (and, through professional marketing, bring all logical bidders to the table), they also yield something that is critically important today: real-time data about what properties are actually worth in the disrupted marketplace.

In a Section 363 sale, moreover, the secured creditor enjoys an additional layer of protection: the right to wholly or partially cancel that borrower’s debt in exchange for those assets—no cash required—in a credit bid. Acting as a qualified bidder in this way enables lenders to provide price support for structured deals even as they avoid the potential costs (in both time and money) that are so often associated with commercial foreclosures.

That’s no small point when you consider that many commercial properties may require adaptive reuse to be viable moving forward. Taking these properties back, in other words, can be a risky proposition. Consider a conventional process in which a commercial real estate broker sells a hard-hit regional mall on behalf of the lender.

Even before COVID-19, many regional malls were ghost towns. Now, it’s even less viable to move forward with such assets as 100 percent retail, and so the likeliest scenario is one in which the buyer makes the bid contingent on the approval of new, non-retail uses. Ultimately, that means the lender could face a situation in which a thwarted buyer sends an email along the lines of, “Unfortunately, our adaptive use strategy has hit a roadblock: The city will not allow me to make this a data-center and industrial development. I’m discounting my price by $10 million.”

In taking such properties back amid such contingencies, lenders effectively become buyers’ development partners—not exactly the business they want to be in right now. Structured sales enable lenders to avoid this potential trap. They involve the sale of an individual asset or an entire portfolio on a non-contingent basis, all at once. It’s a process that allows both the estate and the lender to maximize price as well as control the timing and terms of sale.

Example of a Structured Accelerated Sale
The 2019 structured bankruptcy auction of the main campus of the College of New Rochelle in New York’s Westchester County illustrates the benefits of this process to secured creditors. Our firm and a joint venture partner sold the 20-building campus—425,000 square feet of buildings along with a historic 19th-century castle—for $32 million.

Even then, the market value of the 15.6-acre property was uncertain, due in no small measure to a serious constraint in play—the preferences of city officials and local community groups regarding how the campus could be reused. From the outset, multiple developers showed intense interest in the assets, but city officials and local community groups ultimately made clear that they wanted to preserve the look and feel of the campus, which meant that putting in huge new office or residential towers was not on the table. This highlights the importance of meeting with municipalities to understand their perspective whenever plans for a major property involve adaptive reuse. It’s the kind of fact-finding that is more likely in a professionally marketed, structured process.

The joint venture partners ran a stalking-horse process that generated a $22 million bid. Ultimately, the campus sold for $32 million, on an all-cash, non-contingent basis, after a professionally marketed, competitive auction.

The College of New Rochelle was a difficult-to-value asset, because its future use was unclear. However, the top three bids all came in within $1 million of each other. It was an absolute demonstration to secured creditors of what the property was worth at that time.

An Effective Workout Strategy
To describe today’s real estate landscape as uncertain is an understatement. While accumulated sale results will eventually give the ABL community a better sense of recalibrated asset values in broad terms, the marketplace continues to change so quickly that lenders need a way to gauge real estate asset values in real time, right now.

For precisely this reason, structured sales are worth considering as a workout strategy. When professionally marketed and executed, they can provide lenders with a sense of certainty in a highly uncertain time.