As of the end of last year, there had been a 20% plunge in commercial property values since March 2022 and a record high of 630,000 UK businesses in 'significant financial distress'. There has been a surge in real estate assets coming to market via fire sales through both the formal and informal insolvency processes. This trend is likely to continue as costs continue to increase for many businesses with real estate assets at their core (hotels, pubs, restaurants, offices, care homes, development projects, educational facilities). For savvy real estate investors, this presents a rare and lucrative opportunity, but there are some key issues to consider.
- Title guarantees and warranties: Distressed properties are sold "as seen" with limited or no title guarantees, meaning buyers take on more risk while sellers accept lower prices. Is this risk manageable? Almost always. Investors must conduct thorough legal and title due diligence. Although insolvency sales are fast-paced, full Land Registry, local authority, and environmental searches are often possible.
Administrators, receivers, and lenders may be willing to wait for buyers to complete their due diligence for the right price. If information is missing or there are title concerns, indemnity insurance can offer protection. The cost of this insurance is usually less than the discount on the sale price, and brokers and insurers are accustomed to working quickly in these situations.
- Speed and agility: Investors should anticipate a swift sales process, offering agile investors and advisers a chance to outpace competitors. Initial bids, often non-binding, are based on a desktop valuation to identify serious contenders. The goal for a keen investor is to progress past the first round to access detailed information and conduct more thorough due diligence. Bids can be adjusted if further diligence reveals value issues. Although insolvency practitioners may set tight deadlines, they are willing to wait for serious bidders offering the best value. Institutional lenders behind distressed real estate aim to recover as much debt as possible, even if it means waiting a bit longer.
- Dealing with security and charges: Some sellers may have numerous mortgages and charges registered against a title. Even if junior lenders don't agree to a sale, their legal charges can be dealt with. It is the senior lender's interests that will take precedence. A senior lender can ultimately overreach the interests and securities of a junior lender using the mortgagees' power of sale under the Law of Property Act 1925. This is a powerful remedy for lenders and receivers to override junior restrictions on the title register and deliver a clean title to buyers. In extreme cases, an administrator can use statutory powers to request the courts to sanction a sale of a property free of fixed charge interests. English insolvency courts and practitioners are skilled at swiftly handling these cases, using legal tools to counter uncooperative mortgagees and facilitate the quick sale of distressed assets.
- Buyer indemnities: In a distressed sale, insolvency practitioners avoid ongoing liabilities. Navigating a distressed trading asset, like shopping centres, hotels, and care homes, comes with complexities. There will be employees, suppliers, and customers. Under the Transfer of Undertakings (Protection of Employment) Regulations 2006 (known more commonly as the TUPE regulations), employee rights often transfer unless redundancies occur pre-sale. Unpaid suppliers might claim retention of title on inventory, and customers could have pending orders or deposits. A seller will expect indemnities to be given by a buyer on a sale to cover any potential liabilities relating to these. A savvy buyer will often seek to limit these indemnities both in value and in time.
- Management issues: An investor should always conduct due diligence on any rent arrears and service charge accounts. Distressed assets such as retail units may have void premises or outstanding insurance claims. A buyer can make recovery of these costs a condition of the purchase. There are also opportunities to ask sellers to terminate operating businesses and leases to deliver vacant possession. The costs and claims of doing so are seller costs and claims. Administrators can also grant licences to buyers of valuable leasehold, pending formal assignment of leases. All these issues are negotiable and knowledgeable investors, and their advisers are adept at finding a route through these issues. They will rarely affect the value proposition in a distressed real estate investment.
While distressed real estate presents various challenges to an investor/buyer, it also offers unique opportunities for those willing to navigate its complexities. With careful consideration, due diligence and good legal advice, these challenges can be transformed into profitable ventures in the long term.