Last year our company analyzed, valued, and submitted bids to purchase performing and nonperforming residential land and construction loan assets in the western United States from numerous major lending institutions.

We reviewed thousands of pages of documents in due diligence packages provided by loan portfolio and land brokers.

The process revealed that there is a lack of accurate information about the underlying assets within lending institutions, that many banks are not managing real estate assets to preserve value, and that there is tremendous opportunity to improve the asset sale process. These findings were reinforced through several discussions with contacts in the banking and real estate brokerage industries.

We would like to provide practical advice to banks and other lending institutions about ownership of real estate from the point of view of a solvent real estate developer and builder that has been a prospective purchaser throughout the last year.

Understand the underlying asset. Don't simply rely on one appraisal that may be out of date and based on faulty assumptions. In addition to an appraisal, have two independent developers review the assets and provide feedback.

Find a new operator/developer when a loan cannot be restructured or the borrower has become insolvent. It should be obvious at this point that the interests of the borrower and those of the lender diverge dramatically, and that a new operating partner with an objective view of the asset must be sought.

Preserve or improve entitlements. Difficult-to-obtain entitlements and environmental permits expire and must be extended. Hire a development professional to assess and perfect entitlements on all assets. Some agencies are considering deferring development and impact fees. Deferred fees result in increased land value.

Sell completed inventory that will deteriorate if it is not occupied. Potential value becomes a liability if a property is vandalized or deteriorates to the point that it requires repair. Sell inventory through a real estate broker or a bulk sale. The longer units remain unoccupied, the higher the liability.

Finish in-progress homes while minimizing construction defect litigation risk. Consider entering a traditional joint venture or a participating loan with a solvent local builder to finish and sell these homes. A builder may be willing to accept the long-term warranty and construction litigation liability if a warranty reserve is funded at the close of escrow and there is potential to earn a fee on the sale. Many builders are seeking cash flow and would be open to this type of arrangement.

Put the right people in the other real estate owned office. You need people with experience handling REO asset sales in this position, and it is critical that this function not be performed with people who were involved in originating the loans to be sold. It is human nature to resist the diminution of one's own work (selling a loan for 50% of its outstanding balance, for example). An efficient sale process depends on an objective decision maker taking into consideration the firm's broader interests.

Provide useful information. In our experience, the documentation provided by banks in due diligence packages consistently lacked critical information.

Before listing the assets, hire a real estate professional with entitlement, construction, and sales experience (there are many currently looking for work) to assemble information that does not exist in bank files, such as permit and impact fees, infrastructure cost estimates, and entitlement issues.

Conduct construction inspections, and ensure that the reports are comprehensive, so buyers know exactly what they are buying. Buyers will compensate for a lack of information (increased project risk) with a lower offer (higher project margin).

Consider the differences between buyers of notes and buyers of real estate. Public builders will not purchase notes. The sale price will be significantly lower than that of real estate, because of the increased uncertainty associated with a note and a lack of foreclosure competency within the current buyer pool.

Consider seller financing. Much of the capital pursuing this type of purchase demands an internal rate of return of 20% to 30%. This type of investment requires a hold period of between two and seven years with no income. Seller financing will greatly increase land value in most cases.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.