With depressed real estate and capital markets, capital is used to purchase defaulted commercial real estate loans at discount.
Though there are returns in this type of investment, when buying distressed mortgage debt, do not focus entirely on price. Do a valuation on a net present value basis or capitalization rate basis, studying the cash flow and liquidation value of the real estate, the expenses, and time it will take to complete a foreclosure to convert the loan into real estate ownership.
Depending on the quality of loan documents and history, the borrower may have claims that can delay a foreclosure on the collateral and reduce the return to the loan buyer. While the real estate asset securing the loan is the source of repayment, the buyer of loans is not buying the real estate collateral. Though lender rights include the ability to foreclose on the mortgage and become the owner of the real estate, the loan buyer is acquiring the loan documents.
Sometimes the real estate collateral may need to be recovered out of a borrower bankruptcy, delaying the time to market and sell the real estate. The lender wants to avoid the borrower filing bankruptcy because of an automatic stay against the lender going for a mortgage foreclosure. Look at the loan documents to see if there is a "carve-out guaranty," where the person/entity controlling the borrower agrees to become liable on a recourse basis for the loan. The guarantor will become personally liable for the loan if the borrower files bankruptcy. These guaranties have been found enforceable by courts and are effective to deter bankruptcy filing and enhance the mortgage loan value.
When seeking opportunities in the distressed debt marketplace, engage a bankruptcy attorney to assist in evaluating loan documents.
