Buying Commercial Real Estate in a Crash: Beware of Hidden Debris

Book: The Commercial Real Estate Tsunami: A Survival Guide for Lenders, Owners, Buyers, and Brokers Author: Tony Wood (Foreword by Matthew Anderson) ISBN: 978-0-470-63637-4 Chapter 8: Buyers Beware of Hidden Debris

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So the market crashed. Values dropped 40 to 50 percent. And now you are thinking: this is my chance to buy something cheap. Right?

Tony Wood opens Chapter 8 with a warning. Yes, there are deals out there. But the phrase “buyer beware” has never been more relevant than in a distressed real estate market. And if you rush in without doing your homework, you might end up owning someone else’s nightmare.

This Is Not Like Buying a House

Tony makes this point early and it is an important one. A lot of people who made money flipping houses during the residential crisis figured they could just jump into commercial real estate and do the same thing. Bad idea.

Commercial real estate is a completely different world. The way you value properties is different. The leases are different. The risks are different. The financing is different. If you do not understand cap rates, tenant profiles, and commercial lease structures, you are setting yourself up to fail.

And even if you are an experienced commercial investor, Tony warns against overconfidence. The rules that worked during the boom do not apply anymore. This is a new market with new dynamics. Driving while looking in the rearview mirror does not work here either.

Tony mentions seeing buyers purchase properties at 2007 prices in 2009. They overpaid by 50 percent. Why? Because they did not do their homework and they did not have the right people advising them. That is an expensive lesson.

Cash Is King (No, Really)

You have probably heard this saying a million times. But in a distressed commercial real estate market, it is literally true.

If you can pay all cash, you are in a very strong position. Sellers, especially banks trying to get rid of foreclosed properties, do not want to wait 60 to 90 days to find out if your lender will actually come through with the financing. They want certainty. They want speed.

So all-cash buyers get the best discounts. They close faster. They have fewer headaches. And in a market where getting a commercial loan is nearly impossible, being the person who does not need one gives you enormous bargaining power.

Skip the Courthouse Steps

Here is a myth Tony busts wide open. A lot of people think the best deals are at courthouse foreclosure auctions. They heard it from a friend, or from some guy at a seminar, or from a YouTube video about getting rich in real estate.

Tony says this is mostly wrong.

Yes, you can sometimes find deals at courthouse auctions. But there are big problems:

Limited selection. You are stuck with whatever happens to be for sale at that specific auction. If you are looking for a particular type of property in a particular area, the odds of finding it on the courthouse steps are low.

Professional competition. Groups of experienced investors specialize in nothing but courthouse purchases. They know the game. You do not. Tony mentions a term from the 1970s: “the 40 thieves.” These were regulars at foreclosure auctions who would sometimes conspire to outbid newcomers.

You need cashier’s checks. Plural. You show up without them, you are not bidding on anything.

Very little due diligence time. You are often buying with minimal information about the property.

Tony’s advice? The open market will have plenty of deals in the coming months and years. Troubled assets, commercial short sales, bank-owned properties. All available through a much more straightforward process that gives you time to actually investigate what you are buying.

The “Hair on the Deal”

This is my favorite term from the chapter. In commercial real estate, when a property has hidden problems, they say it has “hair” on it. And distressed properties tend to have a lot of hair.

Some of it is obvious. The building is completely vacant. Construction was never finished. There is no certificate of occupancy. Those things are visible and you can price them into your offer.

But it is the invisible stuff that can really hurt you:

Title issues. Tony shares an example where the sole access to a shopping center was through an easement over a culvert, and that easement was expiring in 15 years. The lender who made the original 10-year loan did not care. But as a buyer who plans to own the property long-term? That is a huge problem.

Owners association problems. A building can look perfect from the outside but be wrapped up in lawsuit threats and financial chaos from a dysfunctional owners association. Tony says to always get at least three years of meeting minutes and financial records. You will be surprised what you find.

Missing information. When a borrower surrenders a property to the bank, they often take their records with them. Or the records were incomplete to begin with. The bank may only know the basics about the property. All the detailed information about deferred maintenance, tenant issues, and physical problems might be gone.

Lender knowledge gaps. Banks are not property managers. Their Special Assets departments are often overwhelmed and understaffed. They may not have the resources to fully evaluate every property in their portfolio. So when they sell you a building, they genuinely might not know what problems exist.

Due Diligence Is Everything

Tony and his experts hammer this point home. In a distressed market, due diligence is not just important. It is the entire game.

Here is the checklist based on what the chapter covers:

• Get proper financial data on the property
• Review every lease and tenant profile
• Do tenant interviews and get estoppel certificates confirming lease terms
• Review all service contracts
• Get structural and environmental reports
• Do a thorough physical inspection
• Get adequate title insurance, and consider buying extra endorsements for coverage against unknown issues
• Check for deed restrictions, code violations, construction defects, and easement issues
• Look at ingress and egress (how people get in and out of the property)

And here is the big one: understand why the property is in trouble. Is it just overleveraged? That problem is solved by buying at a low enough price. But is it in a bad location? That cannot be fixed at any price.

Tony puts it simply. The discount you get on a distressed property should directly match the cost of fixing whatever is wrong with it. If the problems cost more than the discount, walk away.

Get the Right People on Your Team

This chapter circles back to a theme that runs through the whole book. Do not try to do this alone. Get experienced commercial real estate brokers who know the local market. Get a good attorney. Get proper title coverage.

Tony mentions that you can hire a broker as a consultant on a flat fee or hourly basis, not just on a commission. That is useful if you are exploring the market and want professional guidance before committing to anything.

And he makes a point that applies to any investment: the money you spend on good advice will save you many times over compared to the cost of a bad purchase.

My Take

Chapter 8 is the shortest chapter in the survival guide section, but it might be the most practical for anyone thinking about buying commercial property during a downturn.

The core message is simple: opportunity and risk come packaged together. The same conditions that create great deals also create great traps. Properties are cheap for a reason, and it is your job to figure out what that reason is before you hand over your money.

What I appreciate about this chapter is that Tony is not trying to scare people away from buying. He is trying to make sure they buy smart. Do your homework. Get proper representation. Do not skip due diligence just because the price looks good. And if you have cash, use that advantage wisely.

The “hair on the deal” concept is one of those things I wish every new real estate investor understood. Every distressed property has hidden problems. The question is not whether they exist. The question is whether you found them before you closed the deal.

This is part of a series covering “The Commercial Real Estate Tsunami” by Tony Wood. The book was published in 2010 by John Wiley & Sons.