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The institutional counselor.

Most of the literature on real estate counseling has been written by real estate counselors in private practice for real estate counselors in private practice. One reason for this phenomenon is that, until recently, there has been little need for real estate counselors within the institutional environment.

This situation is changing, however. Not since the Great Depression has there been such a crisis in the real estate and mortgage lending industry. Problems associated with deregulation, overbuilding, unfavorable changes in the federal tax laws, and fraud and other crimes have devastated the savings and loan industry. While the commercial banking industry has not experienced all the problems intrinsic to the savings and loan industry, commercial bankers have also had to face some of these difficulties.

Enormous increases in real estate foreclosures have resulted in both private and public institutions owning substantial amounts of real estates (called REO). Regulatory authorities have responded to the increases in private institutions' REO inventories by requiring such institutions to write down loans that are no longer performing (1). These write-downs have a direct impact on an institution's balance sheet, adversely affecting its net worth, value, and federal capital requirement. Such negative effects have encouraged private institutions to dispose of and resolve REO assets.

Traditionally, private institutions have been concerned with managing debt or mortgage positions Real estate lenders have thus established proficiency in securing interest income, maximing yields, and servicing loans. As a result of high rates of foreclosures in the 1980s, however, many lending institutions took on roles as property developers and managers. These were roles they knew little about and their lack of experienced exacerbated the current problems in the real estate market. In addition, federal regulations that allowed savings and loan institutions to enter into direct investments further intensified the problem-loan crisis. While expertise had been established in the underwriting, appraisal, title, and escrow fields, the staffs of most institutions lacked the expertise with ownership positions necessary to efficiently and effectively manage and dispose of troubled assets.

Some institutions have realized the benefits of retaining outside private real estate counselors in the current environment. Large REO inventories and limited financial capabilities have caused other institutions to attempt to perform these functions in-house.

The purpose of this article is to provide in-house institutional counselors with some basic ideas and a frame of reference from which to operate. It should be noted that this article is not intended to make in-house counselors experts in real estate counseling, but rather to point out areas that may be explored in various situations. When dealing with high-profile or large-dollar assets, an in-house counselor may find it extremely beneficial to retain outside, private counseling expertise.

What is real estate counseling? Real estate counseling is defined by the American Society of Real Estate Counselors (ASREC) as:

Providing competent, disinterested, and unbiased advice, professional guidance, and sound judgment on diversified problems in the broad field of real estate involving any or all segments of the business such as merchandising, leasing, management, planning, financing, appraising, court testimony, and other similar services. Counseling may involve the utilization of any or all of these functions. (2)

As in any problem-solving enterprise the first step is to define the problem. Once an institutional counselor has defined a problem and is familiar with the subject asset it is essential to consider the decision-making process. This process involves a step-by-step procedure that enables an institutional counselor to analyze carefully and systematically each of many factors that affect the return, riskiness, and value of the real estate asset, and provides an operational framework for achieving the financial objectives of the firm. The decision-making process might include identification of the following items.

* Objectives of the institution, including strategic objectives and priorities as well as tactical alternatives acceptable to the institution.

* Legal-political constraints, including zoning constraints, regulatory constraints on the institution, and outside political forces.

* Environmental constraints such as hazardous waste issues and environmental impact.

* Ethical constraints, including the impact on the physical qualities of the land as well as the image of the institution.

* Economic constraints, which may be to maximize profit and minimize loss.

These decision-making criteria are interrelated and thus should be considered in relationship to each other. An institutional counselor should ask whether a potential solution will succeed in both solving the problem and achieving the objectives of the institution while at the same time interfacing with the other decision-making criteria.

It becomes apparent at this juncture that collaboration among various professionals will be necessary. An institutional counselor is not expected to have all the answers, but should be capable of asking the right questions of other professionals who can offer expertise in related areas.

As an example, an institutional counselor may determine that an objective of the institution is to dispose of troubled assets in a timely manner, realizing the greatest possible net present value.

A decision to use the tactical alternative of foreclosure on a non-paying asset may be abrogated, however, if environmental analysts find evidence of toxic wastes on the property. The costs associated with removal of hazardous wastes often exceed the value of an individual property, and it may be prudent to leave that problem to the property owner along with ownership of the property.

In another instance, converting an apartment project to condominiums or rezoning a residential lot to commercial use may result in a higher and better use of the property, in turn causing a higher net present value. This tactical alternative may be thwarted, however, by zoning and land use regulations. An institutional counselor may find that converting an existing apartment to a condominium is the highest and best use of the property and is consistent with zoning and land use regulations. The condominium conversion, however, may result in the eviction of long-term elderly or low-income tenants. Consequently, this may not be an acceptable alternative under the "ethical constraints" decision-making criterion because of the potential negative impact on the institution's image.

When a mortgagor has displayed a history of successful and competent management, especially with complex properties, it may be more expedient for the institution to restructure the loan. Restructuring the loan (i.e., revising loan amounts or interest rates) can reduce a mortgagor's debt service to a point at which the loan can be brought into a performing status again. Such restructuring may involve the institution's partial ownership of the real estate asset and participation in future cash flows and residual proceeds of the property.

An institutional counselor generally starts with an analysis of the economic constraints of the problem. This may be done by examining the economic characteristics of the subject property. Such analysis is likely to entail an appraisal, a feasibility study, a market study, and a marketability study.

An appraisal is designed to establish the most probable selling price of a property. The appraisal may also contain the feasibility study, market study, and market-ability study. Feasibility studies test the ability of given investment alternatives to meet explicit objectives (e.g., cash flow expectations) by analyzing all contributing and limiting factors and determining which combinations meet the institution's criteria. Market studies are macroeconomic studies that relate to supply and demand, demographics, pricing, and construction and absorption trends. Marketability studies are microeconomic studies that focus on the marketability of a given property or class of properties to determine a specific highest and best use, to test development proposals, or to project an appropriate tenant mix.

For many troubled assets, an in-house institutional counselor may use the five decision criteria previously mentioned to arrive at sound disposition alternatives. When a troubled asset is a large or complex property and the disposition decision has potentially far-reaching consequences, however, it is prudent to retain outside real estate counsel. An outside counselor may have greater scope and depth with regard to a particular market segment than the in-house counselor. Further, the element of objectivity may occasionally place an in-house counselor in an awkward situation with respect to his or her organization. A disposition decision could result in internal political difficulties that challenge an in-house counselor's loyalty to the firm. Use of an outside real estate counselor can reduce organizational pressures that may influence an in-house counselor.

Finally, an institutional counselor must receive cooperation from the institution's staff. An in-house counselor's endeavors encompass many variables that are germane to other operational areas of the firm (e.g., legal, accounting, engineering, governmental). Personnel in these operational areas have information that is essential to the decision-making process. Cooperation between a firm's staff and the institutional counselor will increase the likelihood of optimal real estate investment decisions.

(1) Specifically, the regulatory agencies are the Federal Home Loan Bank Board, the Office of the Controller of Currency, and the Federal Deposit Insurance Corporation.

(2) American Society of Real Estate Counselors, What is Real Estate Counseling? (Chicago, American Society of Real Estate Counselors, 1962), 14-15.

Patrick M. Walker, MAI, is a real estate counselor and consultant at Sell, Huish & Associates in Las Vegas, Nevada. He received both a BA and an MBA from the University of Washington. Mr. Walker has published several articles on real estate matters.
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Author:Walker, Patrick M.
Publication:Appraisal Journal
Date:Apr 1, 1992
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