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Implementing the management transition at distressed properties.

The slump in many multifamily real estate markets has resulted in a record number of multifamily housing developments ending up in the REO portfolios of major and minor lenders and other providers of mortgage guarantees. Most of these new owners have neither the capability nor the inclination to operate and manage these properties. As a result, most are turning to outside sources for management expertise and advice.

This need for management assistance by financial institutions has created a significant niche for firms that can display an ability to cope with the various problems associated with the management of a distressed property. For the purposes of this discussion, we define "distressed" as property which has been acquired by a lender or insurer as the result of the foreclosure process.

Making the contact

As with many types of management business, work in managing REO properties most often comes from repeat business and referrals. However, for managers interested in breaking into the field of managing distressed and REO properties, acting as a court-appointed receiver is one way to gain experience and exposure.

Often the first opportunity a manager has to manage a distressed property comes though an attorney/associate who needs a receiver. The attorney usually recommends the prospective receiver to his her lender/client.

If the lender approves, then the attorney will petition the court for the appointment. If the court appoints a receiver, this person or organization becomes responsible to the court for overseeing and preserving the property.

Prior to accepting appointment, the manager should consider several issues. First, the receiver works for the court, not the attorney or the lender. The receiver's responsibility to the court may, at times conflict with the best interests of the lender, for whom the receiver hopes to work after the lender takes possession.

For example, the receiver may be directed by the court to pay the past debts of the borrower with existing cash flow. Yet, the cash available at the end of the receivership period goes to the lender to satisfy outstanding interest accrued on the debt. Thus paying the debts of the property would reduce the amount of cash available to the lender once the receivership is terminated

The receiver should also be aware that the receivership period may be a long one. In such cases the receiver may be in a "hold" position, in that no capital improvements may be made to the property unless approved by the court. As a result, the property may deteriorate during the receivership. The manager must then face concerns that the property's condition is damaging to management's reputation in the community or poses potential liability risks.

A receiver must be bonded before the appointment can become official, and not all managers qualify for bonding. A prospective receiver should contact his or her insurance agent to determine if bounding is viable.

Once the lender is in possession and has title to the property, management's responsibilities and legal status change. A final report is prepared for the court, including a final accounting of the receiver's funds.

If the management was retained, its status becomes clearer. Legally, the management/owner relationship for an REO is similar to that with other clients. However, one important difference exists. For the most part, financial institutions are not, nor do they want to be, in the business of owning real estate - they have been forced into it.

As a result, it is up to management to provided the lender with the information to decide whether to sell the property "as is" or to repair the property, hoping the additional cost will increase marketability and sales price. However, the manager also faces other problems.

Dealing with on-site personnel

Many problems exist for management when initially taking charge of an REO. First and foremost is dealing with onsite employees.

Typically employees have been given very little notice that the property will no longer be managed by the current entity and will have new owners. In a receivership, employees are placed in limbo. Therefore, it is important to meet with all of the property's on-site employees as soon as practicable after takeover of the property.

Management seldom has a legal obligation to keep an employee, unless through an arrangement between the past and current owners. Each employee should be informed of the general circumstances of the change in management and should be told as soon as possible if he or she will be retained.

It should be noted that the employees immediately come under the policies and guidelines of new management. This would include health insurance, vacation, sick leave, bonuses, and other areas. Employees who are kept should be made fully aware that although they still work at the property, they are "new" employees of management and the accrual of vacation, sick, and other forms of leave and benefits begin the day of their hire by the new management, not the day they started with the property.

The property manager should be interviewed first to determine if this person should be retained. Sometimes a quick interview can readily lead to the conclusion that the manager may have contributed to the property's downfall. If it is deemed best to start over, then a manager can be brought from another property or from the central office on a temporary basis to assist until a new manager is hired.

If the property manager is retained, he or she is probably the best suited to analyze the rest of the on-site staff. The manager can give new management a detailed review of the property's needs. Management should always be ready for a worst-case scenario when staffing a property and should have the capability to temporarily replace staff from within the company.

The staffing schedule prepared prior to taking over the property should be followed, however, Even if new management likes all of the employees, one of the property's problems, may have been overstaffing. As a result, management should follow its staffing schedule unless closer inspection of the property reveals additional staff to be necessary.

Notification of residents.

Residents should be notified soon after staff of the change in management. Notices should be prepared and delivered to each apartment. The notices should contain the name and mailing address of management; daytime and emergency telephone numbers; the name of the property manager; where to pay rent; and the effective date of the change.

The notice should also state when apartment inspectors will begin and explain any rule changes of which management is aware at the time.

Management should also make a concerted effort to alleviate tenant fears of increased rents and ignored work orders as a result of the changeover. A meeting of residents would be most appropriate to help familiarize them with new management as well as addressing other concerns, such as the status of security deposits.

Analyzing income and expense

Management needs to obtain an accurate rent roll soon after takeover. Reliance on the rent roll provided by former management or owners can lead to trouble. Occasionally, in an attempt to stave off foreclosure or to attract buyers, deep concessions are given to new tenants, such as no deposit, one or more months of free rent, or short-term leases. Rent rolls are often outdated, or in some instances, falsified.

Management should personally verify the names on leases, addresses, lease terms, and so forth with residents. A new rent roll should be prepared and compared to the one provided by past management. Changes should be brought to the owner's attention for any potential claims for misrepresentation.

Tenants should be made aware their leases are still in effect and that the transfer of the property in no way voids their obligations or absolves them of the responsibility to abide by its terms and conditions, including the payment of rent.

Leases should be reviewed and matched to a rent roll and a security deposit list, if one is provided. Frequently, security deposits are not transferred to the lender/owner. It is important to consult with the lender to ascertain the agreement between the lender and the borrower as to who is liable for tenant security deposits.

It may be that the lender has agreed to assume certain liabilities of the borrower associated with the property and is prepared to accept the security-deposit liability. In the absence of any agreement to this effect, the tenant has recourse with the previous owner, not the current owner, and should be instructed to pursue a refund in that manner.

A receivership situation is not as clearly defined. The receiver is retained by the court to oversee the property in an impartial manner. Among the receiver's responsibilities are the administration of tenant security deposits and the refunding of such if the circumstances dictate.

If the security deposits were not transferred to the receiver or were spent before a receiver's appointment, it may be desirable to ask the court if operating funds may be used to refund deposits. If operating funds are not available, the receiver's final report to the court should show the security deposits as an outstanding debt of the property. At this point, it will be up to the parties involved with the judge's concurrence to resolve this issue.

Inspection

After determining the status of on-site personnel and lease documents, it is imperative that management begin inspection of all units and common areas. It is important to understand the magnitude of any deferred repairs and maintenance items and to discover any code violations or potential unforeseen liabilities, such as cracked firewalls, inoperable smoke detectores, and unsecured swimming pool areas. These inspections should be summarized and an estimate of the cost to repair obtained.

Items which pose a threat to resident safety or to the property should be repaired immediately. Management should have confirmation from the lender prior to acceptance of a management contract that these items will be repaired upon identification. In a receivership, the receiver should be certain that the appointment court order specifically allows for emergency repairs based on the receiver's judgment.

It is also management's responsibility to inform the owner of the cost to place the property into marketable condition. In this context, "marketable" means not only attraction new tenants, as most distressed properties suffer high vacancy levels, but also attraction buyers.

In authorizing repairs, the owner must decide whether to sell the property "as is" or to repair the property and bring it to a condition which will increase its sales potential. Several factors come into play in this decision, many of which affect management.

One area which often causes difficulties between owner and management is the owner's perception of the market value of the property. Financial institutions sometimes have difficulty understanding that a property appraised for a mortgage at $25,000 a unit has somehow dropped in value to $10,000 a unit in a few years. Their response is, "I know the property hasn't been well maintained over the last few years, but it has to be worth more than that-after all, we're carrying it on our books at $20,000.

In this situation, it is important to offer management's evaluation of the property and provide the owner with the most information possible. If the owner continues to hold lofty ideas on the value, management can go no further without risking damaged client relationships. At the same time, management should not risk damaging its own reputation by endorsing untruth.

Notification of vendors

One of the biggest problems facing new management in the takeover of a distressed property is dealing with vendors owed for past due invoices by the previous management. The problem is particularly acute in smaller communities where these vendors may be the only supplier of a particular product or service in the area.

Management should speak with the vendor and explain the property takeover. Management must make clear that the current owner is not responsible for the debts incurred prior to the transfer of the property, unless there has been an agreement between the lender and the borrower.

In many cases, a court-appointed receiver will have to pay past debts related to the property. However, it is important to note that a receiver is not responsible for debts of the ownership entity,. If debts are incurred on behalf of the former owners and not the property, they will not be paid.

Few vendors will happily accept these circumstances, and most may need to be pacified to some extent. It may be necessary for management to establish a small credit line with the vendor and pay everything else in cash until the vendor gains confidence in the property's ability to pay. In some circumstances, it may be necessary for management to prepay the account and draw against this prepayment as goods and services are needed. Hopefully, after a few months, all local suppliers will extend credit.

Management should instruct the accounts-payable personnel to examine invoices carefully to guarantee payment is only for items purchased after the takeover date.

Be cautious

Managing distressed properties on behalf of lenders offers a wealth of opportunities for property management companies. The slump of multifamily housing in many areas, in conjunction with the collapse of the savings and loan industry, has increased financial institutions' and insurers' REO inventories more than many ever imagined. These new owners are looking for quality management that can assist them in minimizing their losses, or in some cases maximizing their profits, on the disposal of these properties.

However, before property managers flock to offer assistance to this new breed of owner, it is imperative they realize they are entering a different area of management altogether-one that is full of potential pitfalls and liabilities, and one that requires a property manager familiar with the quirks and disparities of managing this type of property.

Marc E. Craff, CPA, is senior vice president of Southeastern Management Center, Inc. and SMC Asset Management, Inc., Lexington, Kentucky. He holds a B.S. degree from the University of Kentucky and an M.S. degree from Eastern Kentucky University. Prior to joining SMC five years ago, Mr. Craft was an audit manager for a Lexington public accounting firm which specializes in multifamily housing.

Southeastern Management Center and SMC Asset Management have been in operation for 16 years, with offices in Lexington and Tampa, Florida. SMC is a wholly owned subsidiary formed to manage distressed properties for lenders and other financial institutions. To date, they have managed 43 such properties for a variety of banks, thrifts, and insurers.
COPYRIGHT 1991 National Association of Realtors
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Copyright 1991 Gale, Cengage Learning. All rights reserved.

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Author:Craft, Marc E.
Publication:Journal of Property Management
Date:Nov 1, 1991
Words:2412
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