The CRE Zombie Apocalypse: Are You Prepared to Capitalize?

Authored by Ken Mann and Jeff Marwil

The commercial real estate (CRE) market is in the midst of a valuation shakeout like we’ve never seen. Virtually every sector, from office buildings, to shopping malls to healthcare facilities, any business or investment reliant on real estate valuations or property related cash flow is in distress. Whether it’s rising interest rates, lingering inflation, or depressed demand, when coupled with a potentially looming recession, the results for CRE are uncertain at best and at worst apocalyptic.

Owners, investors and lenders are bracing for an historic spike in "zombie properties" – assets stuck in a state of suspended animation, unable to generate enough cash flow to service debt or attract investors. Valuations are crumbling and difficult to ascertain to provide a baseline for investment decisions. Given the uncertain state of the market, lenders are reluctant to foreclose, owners with no equity value left in properties are unable to sell at prices sufficient to cover outstanding debt and otherwise unwilling to make further investment in a losing proposition, and typical CRE investors are standing on the sidelines. The distressed and vulture investors are circling above the fray, waiting patiently for the bottom to fall out. The bottom line is that there is no “play book” and therefore, no clear exit plan. While this presents challenges, it also creates actionable opportunities for those who are prepared. In this article, we'll explore the trends in distressed CRE, the impact on various stakeholders, and uncover how bankers, advisors, and investors can navigate this market shift and achieve success.

Factors Contributing to Distressed CRE

The CRE market is undergoing a significant shift. After a period of low vacancy rates and strong valuations, several factors are converging to create distress in many if not most of the CRE market sectors.

• Elevated interest rates: Increased debt service payments impact a property’s cash flow.
• Lingering inflation: Costs of goods and services to satisfy even basic tenant needs and lease requirements are meaningfully more expensive than the costs projected in the models supporting the pending investments in the CRE.
• Potential recessionary pressures: The threat of a recession can dampen tenant demand and lead to tenant defaults with a shift in leverage now favoring tenants.

The Rise of Zombie Properties

Our team at SC&H Capital is monitoring the marketplace situation and witnessing rise of “zombie properties." Vacancy rates are at all-time highs, making it nearly impossible to generate enough cash flow to service existing debt. Takeout financing, which would allow owners to refinance and potentially restructure their loans, is almost non-existent.

Adding to the complexity, lenders are reluctant to foreclose without a clear exit plan and without a viable buyer, lenders are hesitant to take on the struggles, risk, and expense of CRE ownership.

Borrowers, meanwhile, are in a similar bind. Investing additional capital into underwater assets is financially unsupportable. Filing for Chapter 11 bankruptcy to restructure and/or reduce debt can be a challenging option as well, especially in the face of “bad boy” guarantees. This confluence of factors creates a situation where neither lenders nor borrowers can find satisfactory solutions, so the results, for now, are stranded properties with no clear path to recovery.

Impact on Market Stability

The rise of zombie properties can have a significant negative impact on market stability. Vacant and unmaintained properties can drag down surrounding property values, creating a domino effect. Additionally, a large number of distressed properties can limit the availability of desirable commercial space, potentially hindering economic growth.

While the distressed CRE market presents significant challenges, it also offers opportunities for those who can navigate it strategically. Our team at SC&H Capital is not only closely monitoring the situation but leveraging our combined expertise and proven track record to develop tailored solutions for each unique distressed CRE situation.

SC&H Capital: Your Trusted Partner for Effective Solutions in Distressed CRE

With interest rates remaining stable and valuations crashing (or otherwise undeterminable), many CRE owners face difficult decisions. Our experienced team, led by Ken Mann and Jeff Marwil, along with our expert real estate restructuring partners, offer a unique combination of experience and creativity to help navigate these situations and develop value-maximizing solutions.

You already trust us to raise money for or sell troubled businesses. Here’s why SC&H Capital is also your preferred partner for distressed CRE:

• Proven Track Record: Ken (licensed as both an investment banker and real estate agent) leverages his 30+ year career in selling and financing businesses, including CRE assets, while Jeff brings 37+ years of Big Law expertise in CRE workouts, restructurings, and distressed sales.
• Market Expertise: We have a deep understanding of the current CRE market dynamics and the needs of sellers, guarantors, lenders, investors, and buyers. We are uniquely positioned to serve as the trusted “adult in the room,” allowing us to objectively develop solutions and bring parties to the table to achieve a mutually beneficial outcome.
• Creative Solutions: Our team actively collaborates to develop innovative strategies to source financing, maximize value, and negotiate for better-than-expected outcomes for all parties, in distressed CRE situations, including those involving “zombie” properties.

Facing a distressed CRE situation? SC&H Capital can apply the wisdom, judgment, and creativity to organize and complete a competitive sale process and debt resolution within the situationally proscribed time period. Contact our team today.

#distressedCRE #commercialrealestate #workouts #restructuring #distressedinvesting #schcapital