Commercial real estate is distressed when experiencing economic decline or difficulty and is on the brink of foreclosure or has already been taken back by the bank. A property could be distressed for various reasons, such as economic downturns, changes in market conditions, mismanagement, or unexpected events like natural disasters and pandemics.

Due to the change in market demand for some types of CRE that started during the pandemic, the number of distressed properties is increasing as expected, especially in the office sector. According to a recent article by Commercial Observer, Brookfield, the largest office owner in Downtown Los Angeles, defaulted in mid-February on two significant properties worth a combined $784 million. Brookfield’s default was followed shortly by Columbia Property Trust, which owns properties in San Francisco, New York, and Washington. It defaulted on $1.7 billion in debt backed by seven of its office buildings in February. According to Commercial Property Executive, the national office vacancy rate continued its upward trajectory, reaching 16.6% in January, up from the same time last year.

However, distressed commercial real estate is full of opportunities. For new investors, distressed commercial properties are a great way to break into the commercial industry by acquiring quality properties with attractive profit margins since the borrower needs liquidity for other reasons or another deal.

Especially in high barrier-to-entry markets, investors can redevelop distressed commercial properties to create new uses, such as converting a former retail space into office space or residential apartments. Or, since they can purchase the property at a significantly different cost basis than the prior owner, they can reposition distressed commercial properties by making improvements, adding amenities, and rebranding to attract new tenants, increasing the property’s value.

In buildings that are distressed due to age and wear, investors can buy distressed commercial properties, make necessary improvements, and then sell them for a profit. However, after making these investments, the property will still be fully functional for a final cost far less than the replacement cost or the cost of this same asset on the open market just a few years ago. It may require some investment to update building systems.

It is important to note that investing in distressed commercial real estate can be risky and requires a thorough understanding of the market, as well as expertise in property management and renovation. Investors should also clearly understand the risks involved, such as potential liabilities and the possibility of further declines in the market.

Sources:

https://commercialobserver.com/2023/03/default-floor-brookfield-blackstone-columbia-property-trust/

https://www.bisnow.com/national/news/capital-markets/cmbs-delinquency-up-february-trepp-office-117974

https://www.commercialsearch.com/news/office-sector-faces-increased-risk-of-distressed-activity/