Buying Distressed Commercial Real Estate: What Are the Alternatives
| Jurisdiction | Georgia,United States |
| Citation | Vol. 16 No. 4 Pg. 0018 |
| Pages | 0018 |
| Publication year | 2010 |
A Look at the Law
by James B. Jordan and Justin Lischak Earley
The commercial real estate economy is currently mired in what is likely the worst downturn since the Great Depression of nearly a century ago. Indeed, "[b]etween 2010 and 2014, about $1.4 trillion in commercial real estate loans will reach the end of their terms. Nearly half are at present 'underwater' — that is, the borrower owes more than the underlying property is worth."[1] Although this market cycle has wreaked havoc on owners and developers, it will likely create unprecedented opportunities for commercial property buyers. Where the unpaid mortgage balance exceeds the value of the property, even though title is vested in the owner, the owner has no equity in the property and is thus not the true economic owner of the property. Rather, the lender holding the mortgage on the property becomes the shadow owner and an essential party to any transaction.
This article will examine five common methods of buying distressed real property in Georgia[2]: (i) a "short sale" where the property is conveyed by the owner to the purchaser, but only after the lender agrees to accept a discounted loan payoff; (ii) the purchase of the note and deed to secure debt by the purchaser and the later acquisition of the real estate collateral by foreclosure or by deed in lieu of foreclosure; (iii) the purchase of the property at a foreclosure sale; (iv) the purchase of the property through a receivership; and (v) the purchase of the property as real estate owned (REO) from the lender after the lender has acquired the property at the foreclosure sale.
While the lender must necessarily be involved if the owner has no equity, the degree of borrower involvement and cooperation required varies from one approach to another and one situation to another. This is a very important factor, particularly if the property is improved. If the property is raw land, the lack of borrower cooperation may not be a major problem. However, if the property is improved, then the purchaser is actually buying an operating business, and consequently the borrower's cooperation is essential for proper due diligence (e.g., physical inspection of the property, review of leases and financial records and obtaining estoppel certificates from tenants).
Foreclosure Primer
Every real estate loan is made with knowledge of the underlying law, particularly the lender's right to foreclose against the collateral. In order to understand the relative advantages and disadvantages of the various methods of acquiring distressed real property, it is first important to understand how the foreclosure process works in Georgia. Generally, foreclosure in Georgia is a non-judicial process in which the lender, acting as attorney-in-fact for the borrower, sells the property on the courthouse steps after advertising a foreclosure.[3] Here is a roadmap to a typical foreclosure:
▪ Upon the occurrence of a default, whether monetary, non-monetary or a so-called "maturity default" (i.e., failure to repay the debt upon maturity), the lender accelerates the balance due under the loan (if it is not already due) and, barring payment in full, is permitted to advertise the property for foreclosure. The advertisement is conducted in the same overall manner as the advertisement procedure used for sheriff's sales,[4] which includes publication of notice (including the full legal description of the property) in the official legal organ of the county in which the property is located once a week for four weeks immediately preceding the foreclosure sale.[5]
▪ In some cases, a lender may seek appointment of a receiver to aid in consummating the foreclosure.[6] A receiver is typically sought in cases where the rents are subject to dissipation or the collateral is subject to material damage and impairment pending foreclosure. Although many deeds to secure debt permit the appointment of a receiver as a matter of right upon a default, pursuant to Georgia law, the decision to appoint a receiver is wholly within the discretion of a judge.[7]
▪ After the foreclosure advertisement has run, the foreclosure sale occurs on the first Tuesday of the month by public auction on the courthouse steps in the county where all or a portion of the property is located.[8] The foreclosure sale is conducted by the lender, usually through its counsel, as attorney-in-fact for the borrower. Most deeds to secure debt permit the lender to credit bid up to the unpaid balance of its loan, including all "add-ons" such as default interest, attorneys' fees and other matters as may be set forth in the security deed.[9] Since all other bidders are required to submit bids in cash (or cashier's check / certified check),[10] in most commercial foreclosures in Georgia, the lender (or an affiliate) has a distinct advantage by its ability to credit bid, and is almost always the successful bidder and purchaser at the foreclosure sale. Nevertheless, Georgia law requires that the foreclosure process be conducted in such a manner so as to not chill the bidding or otherwise deprive third parties of the opportunity to competitively bid to acquire the property at foreclosure.[11]
▪ If the bid at the foreclosure sale does not retire the entire loan balance, the borrower or a guarantor may be personally liable for the repayment of all or a portion of the debt if the loan is recourse debt—whether fully, partially or only in the event of certain "bad boy" carve-outs to the non-recourse language. Should the lender desire to obtain a deficiency judgment, then the lender must petition for "confirmation" of the foreclosure sale within 30 days of foreclosure.[12] A confirmation proceeding is then conducted by the judge of the superior court in which all or a portion of the land lies, which focuses primarily on whether the foreclosure process was properly conducted and whether the property was sold for "true market value."[13] If these requirements are not met, then the lender is not entitled to a judgment for the deficiency.[14]
Whether a foreclosure actually occurs or not, the lender's foreclosure remedies ultimately drive each potential form of distressed property acquisition. With this system in mind, we turn to the various methods of acquiring distressed property.
Short Sales
A short sale, which is a term and concept borrowed from the residential arena, is the sale of property encumbered by a mortgage for a sales price less than the unpaid balance of the mortgage.[15] In a short sale, the purchaser enters into a purchase contract with the owner for the property to be sold for less than the unpaid loan balance, but the purchase contract includes a contingency in favor of both parties such that obtaining the lender's consent to the discounted payoff of the loan is a condition precedent. While in the past it would have been most unlikely to see a commercial lender agree to a short sale, some lenders will now do so, as it allows the lender to receive cash sooner without subjecting the property to foreclosure, which might "taint" the property and diminish its value. The lender will likely require an appraisal to ensure that the short sale price is at or about the fair market value of the property.[16] If the loan is recourse, the lender may agree to forgive the deficiency in whole or in part, or may simply release its deed to secure debt but maintain its rights to pursue the borrower and any guarantors for the deficiency. Even without a deficiency release from the lender, a borrower may be willing to consummate a short sale because it is thought to maximize the sales price for the property and thus minimize the deficiency claim. Further, avoiding foreclosure may permit the borrower to avoid damage to its credit.
From the purchaser's perspective, the advantages of a short sale include: (i) the purchaser has ample opportunity to perform due diligence, as the selling party is the owner and is cooperative; (ii) the purchaser has the opportunity to obtain title insurance for its acquisition; and (iii) although there may be delays in securing the lender's consent, this approach may be quicker than the other approaches and does not subject the property to the loss of control that may occur when the purchaser waits for the lender to exercise its remedies (i.e., the purchaser could lose the opportunity to buy because the lender could sell the note to another party, another party could buy the property at the foreclosure sale or the lender could acquire the property at foreclosure and then sell the property to another party).
From the purchaser's perspective, the disadvantages of a short sale include: (i) junior liens and interests are not wiped out by the short sale and would continue to encumber the real property, and the property is therefore not subject to the "title cleansing" that occurs via a foreclosure;[17] (ii) there is a risk that if the owner later files for bankruptcy, the transfer could be avoided as a fraudulent conveyance or preference;[18] and (iii) depending on the nature of the lender and the requisite number of internal approvals, obtaining lender consent may take some time.
Purchase of Note
Another possible way of acquiring title to distressed real property is for the purchaser to purchase the note and take an assignment of the underlying security documents. In this way, the purchaser "steps into the shoes" of the lender and succeeds to all of the lender's rights under the security documents. Once the buyer has in essence become the lender, it can take title by foreclosure or by deed in lieu of foreclosure unless the borrower exercises contractual rights to cure the default or retire the debt.
Current anecdotal evidence is that many lenders, particularly special servicers of commercial...
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