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How buyers should position to win distressed real estate deals

While high interest rates slow deal activity, a recent EY webcast shared how prepared buyers can effectively acquire loan portfolios from banks.

In brief
  • Banks are monitoring their commercial real estate exposure, given regulatory capital pressures and economic headwinds.
  • Distress in the current cycle will unfold differently than in cycles past, with banks likely to offload entire loan books before foreclosing on collateral.
  • The ability of a buyer to mobilize quickly and leverage technology can be a differentiator in a market where banks are ready to move assets off their books.

Distress in real estate: How banks and buyers price deals

With $4.5 trillion of mortgage debt outstanding and continuing pressure from high interest rates, there is growing concern about what may lie ahead for the commercial real estate (CRE) industry. Two statistics exemplify these market concerns: per EY analysis, one leading bank’s real estate non-performing loan (NPL) balance tripled from December 2022 to June 2023, with most of the movement occurring in its office loan portfolio. And according to EY research, the average reported mortgage rate exceeded the average reported property cap rate in Q4 2022 and Q2 2023. The last time this occurred was during the 2008 financial crisis.¹

A closer look at this debt tells a nuanced story of why and how the current cycle is different than what we saw during the Great Recession. First, mortgage concerns to date have been concentrated in the regional banking sector. While the overall share of asset exposure to CRE is 26.3% for regional banks, it’s only 6.8% for the larger banks, according to an EY analysis. At the same time, the banking and real estate sectors are still weary from the fallout of certain regional banks in the spring. Secondly, with about $1.5 trillion of commercial loans maturing between now and 2025, banks are less apt to foreclose on underlying collateral as they did in 2008, and more likely to offload potentially troubled loan books to opportunistic buyers. With higher interest rates expected in the near-term, banks are working toward a range of outcomes with borrowers, including loan extensions and modifications. Recent bank disclosures highlight the risk at hand – and the heightened discipline of banks to find ways to avoid sparking new crises.

During the recent webcast, “Distress in real estate: How banks and buyers price deals,” Mark Grinis, EY Americas Real Estate, Hospitality and Construction Sector Leader, led a panel that discussed these market dynamics, and how nuances in the current cycle could impact loan restructuring and future distress. The webcast represented the second in a series around rising levels of distress in commercial real estate, and featured a panel consisting of CRE and banking industry experts including:

  • Scott McLean, President and Chief Operating Officer of Zions Bancorporation
  • Thomas Whitesell, Head of Debt Investment Group – Construction lending, Kennedy Wilson
  • Brett Johnson, Principal and US Real Estate Strategy and Transactions Leader, Ernst & Young LLP
  • Kevin Hanrahan, Managing Director, Valuation, Modeling and Economics, Ernst & Young LLP
  • Dan Brandt, Managing Director, Turnaround & Restructuring, EY-Parthenon, Ernst & Young LLP
  • Devin Rochford, Senior Manager, Valuation, Modeling and Economics, Ernst & Young LLP

Here are four high-level takeaways from the discussion:

Banks are cautious, but have not left the game

The webcast kicked off with perspective on the current state of the CRE market. While distress has not reached a critical point, transaction volume is sluggish, refinancing efforts are difficult and the overall environment remains challenging given where interest rates currently sit.

A slide presented during the webcast illustrated the current payoff rates of commercial mortgage-backed securities (CMBS) by asset class, or said another way, the percentage of CMBS loans that are being paid in full upon at maturity. According to data from Moody’s, CMBS loans collateralized by multifamily, industrial and hotel properties have high payoff rates at maturity, based on loan terms observed in 2023 to date. However, retail properties (particularly regional malls), and office properties continue to face challenges. Based on payoff rates observed as of year-to-date August 2023, Office faces the greatest difficulty in payoff at maturity, with nearly two in three CMBS Office loans maturing in 2023 not being paid off in full.².

One of the webcast speakers, Scott McLean of Zions Bancorporation, made the important distinction that CMBS loans tend to be larger in nature relative to loans originated by regional banks, though regional banks are still feeling the pressure. A discussion on the current state of the banking sector affirmed to this pressure, and the heightened level of discipline of banks relative to prior economic cycles. McLean cited a few risk management strategies adopted by banks since the last recession; in comparison to pre-2008, banks today require nearly twice as much investor equity when underwriting real estate loans. Additionally, to mitigate possible losses, banks have pulled back on financing the outer phases of prospective land deals and have employed action-oriented plans in the case of covenant breaches.

Our panelist additionally commented that that the amount of capital regional banks hold against real estate loans is much higher today than when we entered the 2008 financial crisis. “And we’ll probably go higher,” McLean said during the webcast. “That is going to produce less incentive for banks to be as active in the commercial real estate lending, particularly at higher loan to values, because those are treated more negatively in the evolving capital regimes that are proposed.”

Despite the pressure on regional banks, they remain an important source of financing capital to commercial real estate, and they are not expected to exit the sector.

“The banking industry is a shock absorber for volatile times,” McLean said. “You saw it in 1987, in the early 2000s, in 2008, during the pandemic and in March. Nevertheless, with financing the real estate industry, you just can’t be a regional bank that is important to your regional economy and say you’re not going to provide real estate loans.”

The banking discussion closed by speaking to the opportunities that often arise out of economic downturns. Despite the current uncertainty in the market, all panelists agreed that opportunistic buyers with a longer-term horizon could have great opportunities as the current cycle unfolds.

Banks seek to minimize risk exposure

In a heightened regulatory environment, a panel of EY and industry experts affirmed that banks are taking a more disciplined approach to troubled assets. Instead of foreclosing on collateral and becoming a landlord, banks will look to dispose of or sell large loan books to avoid exposure altogether. Most regional banks simply don’t have the time, energy or discipline to foreclose on and take over properties.

Thomas Whitesell of Kennedy Wilson said banks often take a triage approach to reviewing troubled loans on their books.

“In the background banks are looking at what liquidity they have at the bank, because they know some loans aren’t getting paid off,” Whitesell said. “If you’re the CEO or the risk manager at a bank, you’re going to start looking at this in much more detail. ‘Which one of these assets can I move off the books?’ Banks really don’t want to start taking these back. What they really want to do is find a friendly buyer to be able to sell these at a discount and do it quickly.”

Whitesell added that regional banks are putting much more focus into the appraisal process to ensure they are getting the right value for these transactions. He admitted it’s not an easy task. While prime real estate in markets with stable demand are easy to value, half-empty buildings in need of renovations are a different story, he said, particularly in concerned asset classes such as office.

“Banks just have to be very transparent with the borrower, and hopefully they are going to be transparent with them as well,” Whitesell said.

Buyers may face underwriting with imperfect data

A discussion on the loan books that have closed to date affirmed the different dynamics of this cycle relative to the Great Recession. Because of the way banks are seeking to dispose of loan books, buyers need to come with realistic pricing expectations. Buyers who come to the negotiating table with a reasonable number and approach the discussion with transparency can have an opportunity to get a deal done. Panelists agreed that building a relationship with banks and following through on what you say you’re going to do are keys to moving toward a positive outcome.

“Buyers should not come in at a number and then start re-trading until the last minute,” Whitesell said. “If you develop that reputation, you’re never going to get a second bite at the apple with anybody.” Whitesell also affirmed that the transactions that have closed to date were based on good faith negotiations between bank and buyer; and that further, final pricing and the agreed upon discount to par value reflected the quality of the underlying collateral, and not the historic discounts observed in the prior cycle.

When it comes to underwriting deals, potential buyers are struggling to get good data, said Brett Johnson of Ernst & Young LLP.

“The underwriting data, the information you have on the collateral, is very likely both stale and static,” Johnson said. “It’s a single point in time and based on an outdated appraisal. What we’re seeing is that potential buyers are really having to spend a lot of time asking critical questions; ‘what are the forward-looking valuations? What do we think on occupancy? What do we think on market rents?’ It’s supplementing that older point in time value with information for today.”

While the buyer pool is very well capitalized in private equity debt funds, banks are not looking to increase exposure in that loan market, said EY’s Kevin Hanrahan of EY.

“Investors need to begin planning in advance for transactions in terms of how they plan to mobilize, how they get data, how they are going to underwrite the property cash flows and loan cash flows and ultimately arrive at a price for the portfolio,” Hanrahan said.

Technology is key to mobilizing quickly

Loan books coming to market today have a mix of performing and non-performing assets in them. During a panel discussion near the end of the webcast, EY panelists affirmed the need for an underwriting approach that models out scenarios for the varying loans at hand.

From there, things need to happen quickly, said Devin Rochford of EY. “You really have a very short period of time to come to the conclusion, ‘OK, this is the 10% of loans that I really need to focus my diligence on,’” Rochford said. “You need a robust model that can pull this data, and process and aggregate it very quickly so you can draw those types of conclusions that are going to help you focus your underwriting. You also need to think about the business logic to apply to determine an outcome for each loan.”

The panel spoke about the importance of getting information from borrowers, such as making sure that rent rolls are complete, and thinking about your tech stack looks like to support a quick and thorough analysis. It’s also critical to get data into a usable format, affirmed EY panelists.

“Getting data into a usable format and comparing it with your own market data has to be done quickly and it has to be done at scale,” Rochford said. “Understanding and modeling strategies around distress is absolutely essential. You want to be proactive. There is no one-size-fits-all approach. You need to be prepared, be flexible and have good alignment between your team and your technology.”

Prospective buyers can also identify where they can be flexible and/or creative in getting deals done, said EY-Parthenon’s Dan Brandt.

“You’re going to do a deep dive on the loan docs and one particular area of focus on that is understanding what can and what cannot be done in enforcing those documents,” Brandt said. “That is going to impact your loan resolution strategy.”

Best practices in reviewing the loan documents during the diligence process were further cited by the EY panel; namely, getting quick access to loan files, evaluating any correspondence between the lender and borrower, assessing for any red flags and see if there are any carve-outs or facts that may trigger carve-outs.

“Evaluate multiple loan resolution strategies because if you’re successful in acquiring a loan, something may occur that you didn’t anticipate and you’re going to have to pivot.”


As more large, multi-billion-dollar loan books enter the marketplace, buyers must be prepared to respond quickly to win deals. Distress in the current cycle is likely to unfold differently than the banking crisis of 2008. However, buyers can position themselves for loan opportunities by taking key steps today; building relationships with banks, having the right technology model for rapid analysis and maintaining realistic pricing expectations will all aid in the acquisition process.

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