By Jeremy Cohen, partner

If you told me five years ago that the selling of distressed notes by banks would become a virtual retail industry, I wouldn’t have believed it. Yet here we are, and business is booming. As an example of the frenzy, I recently had three different clients bidding on the same note. Pretty amazing.

Jeremy cohenAs detailed in this article by Elaine Walker of the McClatchy Newspapers chain, Real Capital Analytics says there is about $172.4 billion worth of outstanding, distressed commercial real estate debt.  Whereas a few years ago, banks would have been more inclined to foreclose on a non-performing commercial real estate property, they are now choosing to sell the note.

Why? Banks are in the business of lending money, not owning and operating real estate. By selling the note rather than going through the expensive process of foreclosing, a bank stays out of the chain of title, doesn’t become liable for the property’s environmental conditions and doesn’t have to worry about the time – and expense – of other property-management issues. Add in the cost and effort of marketing the property to potential buyers, and you can see why banks are skittish about going through foreclosure.

For buyers, the benefit of purchasing a non-performing note is clear: the chance to get the loan at a steep discount. After purchasing the note, the buyer has options: it could negotiate a new loan for the borrower, or it could foreclose on the property itself. More often than not, the buyer – often a developer or experienced real estate investment firm who sees a chance to turn the property around – wants to own the site and will foreclose.

Those looking to purchase non-performing notes need to keep the following things in mind:

  • Make sure you know the foreclosure laws in the particular state in which the underlying asset is located. In some states – such as Georgia, with its non-judicial foreclosures – the foreclosure process is straightforward and can be completed rather quickly.  However, in other States, such as Florida, the process can drag on for quite some time.
  • Know how to get your hands on the original note and all related amendments and assignments (i.e., Allonge).
  • Try to procure as much information as possible from the lender about the asset before investing money on due-diligence investigations. The lenders have extensive files about each asset – you just have to push them to release the materials to you.
  • If time allows, procure an updated property condition report and environmental report before purchasing the note, but certainly obtain such a report before completing the foreclosure. The property condition report is crucial in determining any necessary capital improvements and that amount will be used ultimately to determine how aggressive a note buyer can be with the rental rates.