Turnaround Tactics

Reviving troubled assets calls for custom-tailored strategies.

Reviving Troubled Assets Calls for Custom-Tailored Strategies

By Paul Rosta, Senior Editor

By many accounts, commercial real estate assets are getting less distressed. As of October 2012, new additions to the national inventory of distressed assets had declined 33 percent year-over-year, according to Real Capital Analytics Inc. But despite that good news, $167 billion worth of distressed assets remained on the books—a reminder that the demand for skillful management of troubled properties will not disappear anytime soon.
Though no two distressed assets are exactly alike, experts contend that a core set of best practices apply in almost all circumstances. To begin with, owners and property managers must expect the unexpected: unpaid bills, neglected upkeep, disgruntled tenants and the like. “You really never know what you’re getting into until you get into it,” noted Michel.

No matter the property category or level of distress, step one is to ask questions and lots of them. The all-important customer base is the top priority and best resource. “The first thing you have to do once you take over one of these properties is you’ve got to get in front of every one of those tenants,” Michel said. Meeting and interviewing tenants will help the new team determine quickly whether the occupants are happy and where the sore points are.

A need to backfill space is another characteristic task for a turnaround team. Here a big challenge is restoring confidence among tenant reps. “You’ve got to get the leasing community to understand that this is a safe building to do business in,” Michel noted. Brokers who are still owed commissions by the previous owners are wary of being burned again, for instance. “You really have to spend a lot of time reintroducing the property to the brokerage community” and the tenant community at large, Michel said.

Asking the right questions is how Lincoln Property Co. got started in the fall of 2011, when it acquired a 420,000-square-foot office-and-retail complex located in a 70-acre mixed-use development in Huntington Beach, Calif. On the plus side, the 25-year-old complex offered an attractive Orange County location and a 10 percent share of its 2.8 million-square-foot office submarket.

But occupancy had slipped to about 65 percent, in part because a 95,000-square-foot office tower was vacant. So Lincoln reached out to existing tenants for their opinions. “That message is not lost on those tenants when you ask, ‘How do we improve the property?’” said Kevin Hayes, a senior vice president for the firm. Careful listening also helped Lincoln reconfigure a lease for a tenant that was paying above-market rates for excess space. The tenant cut costs; Lincoln retained the tenant.

As an image-building tactic, Lincoln restored the property’s original name, One Pacific Place. All told, the company’s strategy has lifted occupancy above 80 percent, a figure that would be even higher had it not sold a fully occupied 36,000-square-foot retail pad.

Retail Revival
Even though the retail sector accounts for only about 16 percent of all distressed assets—third nationally behind office and multi-family, Real Capital Analytics reported last fall—many retail centers are still emerging from the recession.

Perhaps to a greater extent than for other real estate categories, the window for rescuing troubled retail properties stays open only briefly. Customers will migrate elsewhere when they detect a decline in the quality or variety of retail choices. “What we tell our clients all the time is: Do the research. Figure out what is needed in this particular market and what the customer wants,” reported Greg Maloney, president & CEO of retail for Jones Lang LaSalle Inc.

Whatever the tactics—reshuffling the tenant roster, freshening up curb appeal, even reconfiguring or expanding the center—the goal is generally the same. “If you can attract the right retailers, people will come and shop there. It’s that simple,” Maloney added.

That was the challenge faced by St. John Properties L.L.C. last summer when it took up the task of reviving Harrisburg Mall, a 1 million-square-foot mall in Harrisburg, Pa. Baltimore-based St. John bought the asset from lender TDBank at a significant discount.

Despite its considerable positives—strong location near Interstate 83, solid demographics of its market area and a $60 million investment by the previous owner, Feldman Mall Properties Inc.—the recession had pushed up vacancy to 30 percent by the time St. John stepped in. An 88,000-square-foot anchor store had stood empty since the Boscov’s chain closed it as part of a bankruptcy reorganization in 2008. The recession had also halted construction of a Sega Sports restaurant near one of the property’s entrances, leaving a conspicuous eyesore.

“People want to see this mall returned to the prominent mall it once was,” said Bill Lee, the mall’s director.
Among St. John’s first moves in July 2012 was to demolish the unfinished restaurant and create a 15,000-square-foot public park dubbed The Commons in its place. Other improvements include spruced-up entrances, a security station and new signage.

On the leasing front, St. John particularly wants to enhance the mall’s fashion lineup by building on a foundation that includes a Macy’s anchor store and popular in-line retailers like Victoria’s Secret, Aeropostale, Claire’s and New York and Company. “Our goal is to bring back the woman shopper,” explained St. John senior vice president Gerard Wit.

For distressed assets that are in special servicing or under lender ownership, speed and agility of execution are paramount. Such was the case with a 1.5 million-square-foot suburban Dallas office asset that Cassidy Turley was asked to manage in the fall of 2011. Unable to fix a capital stack problem, the borrower handed over the keys to the lender, CWCapital.

“We had to mobilize quickly,” Michel recalled. Within a week, a rapid-response team representing multiple specialties was on the ground, and a senior property manager had been appointed receiver. In the interest of continuity, Cassidy Turley invited some members of the previous owner’s management team to stay on.
Although astute owners can revive a property with a well-thought-out strategy, others fail to heed the advice of the property’s longtime managers and pursue an approach that is poorly suited to the property, Maloney argues.

He noted that his firm has managed several retail properties for four or five different owners in recent years. After spotting the holes in a new investor’s plan, Maloney recalled, “We’d say, ‘I don’t think that will work.’ ” Too often, the effort would fall short, a new owner would step in, and the cycle would start all over again. “It’s happened, it’s unfortunate, but it’s sort of the real estate business,” Maloney pointed out.

Managers, however, persevere. For tens of billions of dollars’ worth of distressed assets, the next several years will bring the final test of today’s turnaround strategies.