Operating REO and troubled properties

What the property and facility manager must do differently when responsible for managing REO properties

March 2019 — Managing a real estate owned (REO) property is one of the biggest challenges in property management. An REO property is owned by a lender such as a bank or government agency, usually after an unpaid mortgage and then an unsuccessful sale at a foreclosure auction. Numerous resultant problems require a specialized approach to property management. This demands an experienced manager and staff who have the ability to:

  • Quickly assemble resources and data
  • Interpret and analyze that data
  • Articulate recommendation options and their corresponding likely outcomes
  • Assemble an experienced team to execute on the owner-approved asset management plan and strategy

In some cases, the building will be incomplete, and there may be complications in moving forward with development. If tenants are unhappy, potential lessees may be discouraged from moving into the building due to bad press. A critical issue in dealing with REO buildings is that they must often compete among other successful properties that offer competitive market lease rates and amenities. The tenants at those properties are more likely satisfied, the building systems are likely working, and the building is likely ready to accommodate new tenants.

Repositioning a Property

The asset manager of the REO property should strive to operate the property efficiently and to compete with its submarket peer group. The asset manager does not want the REO property to stand out as a distressed, nonperforming asset. Efficient REO management includes:

  • Minimizing expenses and maximizing value by carefully evaluating expenses and increasing occupancy
  • Timely resolution of deferred maintenance at competitive costs
  • Completing any necessary capital improvements and addressing any life-safety or code violation issues
  • Evaluating market conditions and formulating new marketing strategies for leasing
  • Competitive re-bidding of all major service contracts
  • Evaluating tax assessment for equitable tax treatment within the property’s peer group

These measures should result in improving the overall appeal of the property to potential tenants and buyers alike. Ideally, the property will stabilize in a short period of time for a reasonable cost. To achieve a repositioning, there are primary and secondary tasks that an asset manager should perform at this time.

Primary Tasks

Upon acquiring an REO property, the court-appointed receiver (which might be the asset manager or property manager) must protect existing collateral value. This process may involve many steps, including efforts to:

  • Evaluate security and maintenance
  • Insure the property
  • Maintain utilities
  • Inspect mechanical systems
  • Check for hazardous waste
Evaluate Security and Maintenance

Repair deficiencies that are diminishing the value of the property. This includes a comprehensive property condition assessment and prioritization of needed improvements.

Insure the Property

Place an appropriate amount of insurance on the property in case of fire or other damage to the building, effective on the day of acquisition. Liability insurance will protect ownership in case visitors are injured while on the premises.

Maintain Utilities

If there are tenants, the electricity, gas, water, phone service, and any other utility should not be interrupted. Ensuring a smooth transition with utilities will keep tenants happy and help limit problems.

Inspect Mechanical Systems

This inspection must include all plumbing systems (water, sewerage, and drainage), the electrical system, and the HVAC system. It is highly recommended that preliminary environmental research and a survey be conducted prior to taking title in foreclosure. This is accomplished through a Phase I, noninvasive investigation of the property’s history and adjacent uses. If findings dictate further investigation, a Phase II site visit and lab samplings may be undertaken.

Check for Hazardous Waste

The Phase I ESA will inspect the property for any waste issues, including underground gas storage tanks, discarded mechanical equipment, exposed or airborne asbestos, and abandoned, leaking electrical transformers. This inspection is critical and must be undertaken immediately if there is even the slightest suspicion of the presence of hazardous waste, now or in the past. Hazardous waste must be identified and either neutralized in place or removed and disposed of properly.

Secondary Tasks

Secondary measures should also be taken at most REO properties. These tasks generally do not affect the base and physical plant, but they are necessary for protecting the value of the property. Secondary tasks include efforts to:

  • Secure rents
  • Resolve tenant concerns
  • Evaluate the condition of the property
  • Obtain a title report
  • Obtain architectural plans
  • Bid out work
Secure Rents

If there are tenants, make sure that they know who the new owner is and where to send rent payments. In a nonjudicial foreclosure, rents can be attached once the loan goes into default. Advise all tenants about the change of ownership, and obtain copies of existing leases to confirm rent amounts and other terms and conditions.

Resolve Tenant Concerns

Identify and quantify existing tenant complaints and concerns, and resolve as many as possible. This will serve to preserve your existing tenant base and aid in attracting new ones.

Lenders are notoriously poor landlords. The situation of an operating REO can create a great deal of stress and unrest for tenants. In such a situation, the Subordination, Non-Disturbance, and Attornment (SNDA) document executed by the borrower and tenant before the loan was put in service is in effect. This document seeks to establish that the leasehold rights of the tenant are subordinate or junior to those of the lender.

Evaluate the Condition of the Property

Contact all subcontractors who have worked at the property to help determine the property’s current condition. This measure also helps prevent liens from being placed on the property. These contractors frequently are in possession of important history of the property.

Obtain a Title Report

A title report will identify items such as liens, encumbrances, easements, and encroachments. This step must be taken prior to foreclosure. If liens are material and cannot be rectified, then a deed in lieu of foreclosure may be inappropriate. A judicial foreclosure may be the only way to obtain clear title.

Obtain Architectural Plans

You should be able to obtain architectural plans, and preferably as-built plans. These plans may be on file with the municipal or county building inspector. Reviewing these plans can result in saving time and money because they define the current construction status of the property.

Bid Out Work

Bidding out the work to be done on the property should take place as soon as possible. Timing is critical; the new owner will want to use as many of the previous subcontractors as possible because they are familiar with the property and can often save time. A potential drawback is that they may not be the most competitively priced. Check all references of existing subcontractors.

Management Decisions

After the property has been repositioned, additional decisions need to be made with respect to managing the property. The asset manager needs to:

Find a property manager

If the property manager in place is not familiar with the sale process of REO properties, this might be a good time to replace it and hire a firm that can ensure a successful marketing of the property.

Select a leasing agent

Select a leasing agent and a broker familiar with REO properties. Ask about how many REO transactions they’ve handled, how recently, and ask for the property addresses and what kind of results they were able to secure for their clients.

Develop a marketing schedule and meet with advertising agencies

Depending on the size and tenancy of the building, this step may not be applicable or as critical. The leasing agent for smaller properties may assume advertising costs as part of the contractual obligation of the listing agreement.

Evaluate the curb appeal of the property

You may consider changing the name of the property, the decor, the style, and possibly the lobby to create a new image. Whatever the case, the stigma of an REO property must be removed and replaced with the feel of a renewed property and image.

This article is adapted from BOMI International’s Asset Management course, part of the RPA and FMA designation programs. More information regarding this course or BOMI International’s new High-Performance Sustainable Buildings credential (BOMI-HP™) is available by calling 1-800-235-2664. Visit BOMI International’s website, www.bomi.org.