Private Equity and Commercial Notes Strike the Right Chord

Commercial note trading is big business these days, with motivated parties on both sides. Recently, Bank of America agreed to sell a commercial note package valued at approximately $880 million to an institutional investor / hedge fund JV partnership at a discount rumored to be as high as 25% off the original pool value. The note pool was comprised of performing as well as
non-performing assets. On a smaller scale, private equity firms nationwide have also enjoyed healthy returns of lucrative note acquisitions. This segment has great potential for sophisticated investors if partnered with the right private equity firm.

While commercial banks clearly control a substantial segment of available note inventory, smaller equity firms are quietly carving out a successful niche in the note sector with the goal being acquisition of distressed assets. As the pool of desirable commercial assets available for outright acquisition diminishes, investors have turned to distressed note purchases. Institutions holding problem mortgages are extremely motivated to sell distressed notes through discounted sales rather than foreclose and dispose of these assets on the open market at an even greater loss. Unfortunately, due to the inherent complexity of the typical commercial loan deal involving not only the borrower, but also multiple financing instruments used to complete the purchase, along with the fact that lenders don’t openly promote these offerings; it requires an experienced private equity shop with an ear to the pavement to ferret out and negotiate these opportunities. The issues relating to compliance, guarantees, bankruptcy among others are paramount for determining the success of such acquisitions.

One of the greatest strengths private equity firms bring to the table is their willingness to explore a workout solution for existing borrowers in an effort to achieve sustainable returns in the long run. In instances where the borrower is also owner / tenant of the commercial property, the borrower has a vested interest in the property and will be extremely motivated to continue to manage and maintain the property. If a workout is not feasible, private equity firms can often craft an exit strategy that works for all parties. Private equity firms have the flexibility to find ways of making the borrower a part of the overall solution in ways that institutional lenders cannot. This flexibility provides private equity firms with the option to nurture a non-performing note to “performing” and maintain the asset as a revenue source until the market price is right to sell it.

There’s an abundance of capital poised to invest in commercial real estate these days. It’s projected that 2012 and 2013 may prove to be milestone years for commercial investors as 2002 and 2007 vintage commercial notes reach maturity, and short term loan extensions negotiated for some commercial borrowers during the mortgage meltdown come due. It’s our belief that as the availability of profitable commercial assets in top markets become increasingly rare to find, the availability of distressed notes will rise to meet the demand. Investors partnering with the smaller private equity firms not only avail themselves of access to available deals but also to the opportunity of long term gains through restructuring the lending terms with existing borrowers. As a result, these firms create a healthy environment in the commercial market that benefits its investor base as well as provides much needed relief to distressed borrowers in need of alternative financing solutions their lenders can’t offer.