Back office talent key to working with FDIC.

Strong management skills, a proven track record in turngrounds, and deep resources in the back office are just a few of the requirements of property management firms seeking to do business with the Federal Deposit Insurance Corporation (FDIC) and the Resolution Trust Corporation (RTC). And of these three key requisites, the back office set-up is probably most important of all.

Having worked on numerous distressed property turnarounds from the agencies' portfolios, it would be fair to say that proven management expertise is the bare minimum. What is really going to make the difference between success and failure in working with them is a management firm's ability to deal - technically - with the bureaucracy's micro-management of reporting.

For the past five years we have compiled a steady fee income from working with the FDIC. And, along the way, our management team has developed a tight and efficient in-house system for meeting the federal agency's main reporting and compliance standards.

As the FDIC portfolio fattened during the heaviest downturn in real estate values in the late 80s, many private property management firms - and even some development companies - have attempted to enter the "distressed property" turnaround market with varying degrees of success. From our experience, an important component of a successful relationship is the depth of the back office talent available to channel to these projects as distinct from a firm's everyday private sector management assignments. Compliance issues alone, in working with these agencies, dictate which management firms will and won't succeed.

Spot Audits and No Illusions

The shear size of their portfolios is a tempting source of opportunity for management companies struggling to find new business in a depressed marketplace. But a company must be able to tolerate a high level of intervention and oversight that is inherent in doing business with federal agencies. There are no illusions among those firms that have done a number of deals with them about just how much ingenuity it takes to turn properties around in these situations.

When dealing with the FDIC and RTC you have to be continually on top of your game; you can't allow for a sloppy moment in the reporting process because as part of their oversight, they will allow no flexibility in paperwork requirements. They also will spot audit firms engaged in managing their properties. These audits can take place at any time, and you must be prepared to drop everything and provide up-to-the-minute documentation of all activities related to an ongoing project.

These procedures must also be watched over by key appointees in the firm who, as part of their daily responsibilities, deal directly with their service agents in specific areas - whether in leasing, management, or accounting.

Maintaining an Office

Within an Office

What are some of the specific requirements of working with the FDIC and RTC? We have found that the size of the firm is not as important as the way in which it has been set up to do the technical business of property management. Key to meeting compliance issues is a sufficiently powerful and sophisticated computerized reporting system that can be customized to fit the their standards, as well as continue to run the programs for the firm's private sector business. One of the most characteristic aspects of working with a federal agency is the act of filing innumerable reports on a regular basis; this means having in place a very deep back office capability including accounting, computerization and lease administration functions in house.

In addition, many of the accepted practices of the back office - common to most management firms - are quite different for these government agencies. This translates into the need to develop a parallel set of reporting structures, formats, and budgeting procedures just for their projects. Even the standard management statements must be specially tailored for these properties because of government mandates for setting up chart of accounts, income and expense reporting, - in addition to the requisite list of forms that must be completed for each project.

And because management firms doing business with these federal agencies are working predominantly with distressed properties (in many instances as third party managers) they have to be prepared for a whole new level of project oversight.

We routinely spend significant back office time simply transmitting information to their service agents. All of the reporting requirements are rigidly maintained and we work with a Standard Operating Procedure Manual that was designed to oversee this enormous portfolio of projects while minimizing the possibility of fraud. Needless to say, there is very little room in the reporting procedure for creativity.

This fact, on the other hand, necessitates a great deal of creativity in processing leases that not only conform to the FDIC ratios, but also work for tenants and prospective owners should the properties go to auction.

Because we are working under so many constraints in the process, we have to be especially innovative in how we get our leasing done. We also have to be rigorous in our tenant due diligence to get the deal approved. Ultimately, the end game is to get the property back into good operating shape and out for sale.

Of all of the various property types that they have received into their portfolio, the most volatile are retail properties. Among management companies, we believe that retail managers have traditionally tended to be more multi-skilled and marketing-oriented than other types of managers. These specialized talents are especially important in dealing with distressed properties where a multi-level approach to stabilization and value enhancement is essential.

The sheer complexity of the ownership situation surrounding distressed properties necessitates an early intervention strategy just to keep properties from losing any more value or slipping in net operating income while the status of the property is being determined legally.

This is where third-party management becomes its most creative as our turn-around team tries to negotiate a fair balance between a frustrated lender and a troubled owner. As managers, we must be prepared for a number of changes in the property's ownership as it sometimes wends its way through the bankruptcy and foreclosure proceedings. Typically, properties will have passed through a number of cycles before landing in a federal agency portfolio, and this can pose real challenges for third party managers trying to maintain an equilibrium among various owners and tenants - all parties to the eventual outcome of the turn-around.

Working with the FDIC:

A Case Study

The rewards in these particularly challenging turn-arounds, however, far outweigh the added fiduciary responsibilities and difficulties in processing deals. This delicate balancing act is particularly well-illustrated by one of our major third-party management assignments for a property in Greenwich Village in Manhattan.

A 37-store retail complex encompassing East 8th Street, Broadway, and University Place and at the apex of one of Manhattan's most populous tourist districts, the property had been owned by Chicago syndication giant VMS Realty since the mid-1980s. By 1991, trouble was afoot.

VMS had fallen behind in its property taxes by nearly half a million dollars. It was also in default on its first mortgage to Goldome Savings Bank of Buffalo. As Goidome moved to foreclose, VMS countered by placing the property into bankruptcy. Complicating matters was a second mortgage held by VMS's management affiliate.

Meanwhile, 30 of the 37 original tenants at the site were in revolt and had stopped paying in full on what were in many instances by 1991 market standards, above-market rents. Enter Brookhill.

Goldome called us in essentially to salvage its investment. The subsequent turn-around program we devised highlights the range of challenges facing a management company seeking to do business in this climate.

First, we re-evaluated the physical condition and configuration of the property in order to be able to quantify any request for capital to improve and rehabilitate the site. Next, leases were scrutinized to set the value of the property's short and long-term income potential based on a variety of refinancing scenarios and capital improvement programs. Last, we came up with a leasing and marketing strategy that best suited the property and its unique location.

Meanwhile, Goldome had problems of its own, and was seized by the FDIC, which then foreclosed on the 8th Street property. With the entrance of the FDIC, we had to revise our structure of the lease deals we were offering to meet their guidelines and change the reporting requirements. Although this slowed the process some, we were subsequently approved by the Federal Bankruptcy Court in Manhattan to carry out its turn-around program under the aegis of the FDIC.

For over a year, we worked with each tenant to re-negotiate leases where feasible, set up a plan to collect back rents and recover back taxes, and engaged in a series of improvements to bring the property back up to acceptable standards. Finally, we worked with some of the longer-term, larger tenants to literally re-think marketing strategies to strengthen their positions.

In all, we were able to save well over half of the existing leases through renewal, extension or re-negotiation. New leasing efforts brought occupancies up dramatically (to over 90 percent), doubling cash flow from rents (from approximately $1.1 million to almost $2 million) with capital improvements of approximately $150,000.

Notably, when the FDIC brought the property to public auction in late 1992, it sold for $19.5 million - considerably above its preturnaround value of $10-$12 million.

In hindsight, this Greenwich Village property set the tone for what was to come, as more and more properties made their way into the FDIC portfolio over the next few years. To do this kind of work, you have to be a company deep in resources. But, the rewards are significant for those who persevere.