What Is a “Troubled” or “Special” Asset?
“Special” and “troubled” are used interchangeably when referring to assets that are not performing as outlined and agreed upon in the loan documents. The two most common types of default are as follows:
1. Payment Default
Payment default occurs when the borrower is unable to service the debt on time.
2. Maturity Default
Maturity default occurs when the borrower fails to pay the principal balance due at maturity of the loan. The traditional source of such payments is through a refinance. Many borrowers facing maturity are now finding that refinancing loans is more difficult to acquire due to the uncertainty of real estate values and the credit crunch.
When it comes to real estate assets, no product type is immune from trouble. EpiCity has worked directly with private and institutional lenders as well as their borrowers to manage a wide variety of troubled assets including single-family homes, apartment communities, office buildings, warehouses, and self-storage facilities.
What Are The Signs of Trouble?
It’s important that lenders understand the early warning signs that an asset may be headed for trouble. When you know what to look for, it’s easy to spot.
Is the asset properly cared for and maintained? Look at the lawn, the gutters, and the roof. Are there repairs that need to be done? A borrower who fails to invest the time and money needed for basic upkeep may soon struggle to service the debt as well.
Keep your eye on rental rates and occupancy. If these numbers decline, there may be trouble on the horizon.
Is tenant turnover high? Are new tenants less creditworthy? This may indicate a problematic trend.
In short, do your best to stay aware of what is going on. Look at the situation with a broad perspective. An asset can descend into trouble quickly but there are usually at least a few indications that it’s happening. Some savvy bankers tell us they simply get a “gut” feeling.
How Are These Assets Managed?
When a property is identified as troubled, the lender is saddled with a heavy burden. Internally, there is an enormous investment of time and resources committed to the asset to (hopefully) minimize liability and loss with the ultimate goal of making the lender whole.
While a specialist at the bank is assigned to manage the case, someone must also go and physically inspect the asset to determine potential liabilities such as environmental contamination, life-safety hazards, and operational risks. Such issues can create costly obligations for the lender and must be closely evaluated and monitored.
Someone within the bank is also typically assigned to coordinate maintenance on the asset. For most lenders, the goal is to quickly sell the asset and recover the highest possible dollar amount.
In some cases, when a sale isn’t possible or minimally beneficial, lenders will engage an outside company (such as EpiCity) to operate the asset. Depending on the asset type, EpiCity may employ strategies designed to begin generating income or make the asset more capable of being sold.
In recent years, for example, lenders holding troubled lots have typically been unable to sell them as-is. With the help of Epic Development, EpiCity’s partner in residential construction, some of these lenders have been able to turn their empty lots into profitable investments by building new homes on the land, making the asset more attractive to buyers. See our case studies for more detail >>
When lenders fail to appropriately manage their troubled assets, the financial consequences can be devastating.