Duly Noted: Despite Q4 2011 Drop in Distress, Schechtman, Knakal and Others Rack Up Hundreds of Millions of Dollars in the Deals

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Even as commercial real estate prices have improved and banks have swiftly moved troubled loans from their books, the phenomenon of distressed note sales has continued unabated.

According to data from Real Capital Analytics, the volume of newly distressed commercial properties dropped to $12.4 billion for the fourth quarter of 2011—a figure that, as the firm pointed out in its February 2012 Troubled Assets Radar report, is the second lowest level seen in two years.

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2 schechtman and haupsburg bw Duly Noted: Despite Q4 2011 Drop in Distress, Schechtman, Knakal and Others Rack Up Hundreds of Millions of Dollars in the Deals
Haupsburg and Schechtman.

The volume over the past few full year periods has also declined markedly—$140 billion in 2009 to $92.6 billion in 2010 to last year’s full year total of $60.1 billion. So what gives? Why do note sales continue to be the product of the moment—with experts predicting an uptick, not a slowdown?

David Schechtman, principal and executive managing director at Eastern Consolidated, told The Mortgage Observer that he sees the volume of distressed note sales remaining steady for the immediate future because there remains a lot to move through the pipeline. The accuracy of this prediction may be backed up by Mr. Schechtman’s current workload.

“My belief is that, just based on the volume that needs to transact, we are going to finish out this year with a record amount of transactions—both in plain vanilla real estate but also in the loan and distressed world,” Mr. Schechtman said recently at Eastern Consolidated’s offices. “There will still be a significant amount of portfolio lenders and special servicers straight through 2013. Then I think how much transacting there will be on the distress side will be a function of the new administration and some global economic forces.”

For the time being, though, Mr. Schechtman and others dealing in the space have their hands full. For instance, Mr. Schechtman said that he had completed—since January 1, 2012—16 deals, totaling over $300 million.

Over at Massey Knakal, firm chairman Bob Knakal said that his team had done a steadily increasing volume of the deals recently as well. “In 2010 the volume was around $250 million and last year it was about $350 million,” Mr. Knakal said. He added that the firm’s business in this area will probably again increase for 2012.

“The reason that note sales have been so popular, particularly in New York, is because the foreclosure process is so long and cumbersome that it can take three or four years to foreclose on a property and if a lender forecloses the highest recovery they can possibly hope for is 94 percent of the collateral value of the property,” Mr. Knakal said. “One of the interesting things about the market is that generally it was perceived that about halfway through last year most of the banks had worked their way through their problems and that most of the note sales were coming out of special servicers.” This changed, Mr. Knakal said, toward the end of last year when bank problems again resurfaced.

Other experts agreed that the foreclosure process in New York is lengthy—up to four years long—thereby impacting the volume of distressed note sales that take place in the tristate region. During this time a lot can change, including the borrower’s position.

“The thing to remember with note sales is that the borrower has the ability at any time to pay the note off in full,” cautioned Mr. Knakal, whose firm currently has a note on offer secured by the Fordham and Robert Fulton towers in the Bronx. “When an investor is looking at a note—let’s say the property is worth $60 million—the investor might say ‘Hey I’m willing to pay the full amount for the note because I’m buying the property for less than it’s worth. But I have to keep in mind that until my foreclosure is finished I could very easily have the borrower raise the money and pay off the $54 million that’s owed an I’m out.’ And my whole objective was probably to get into the ownership position on the property.”