Going to the Source: Five Strategies for Finding Off-Market and Distressed Assets
In a difficult market, finding true off-market opportunities can be the only way to get deals done. What tactics can investors use to find them?
Today’s Thesis Driven is a guest letter from Jonathan Andrews, Principal at JJA Real Estate Consulting.
With today’s technology and search tools, finding assets to invest in is easier than ever. But finding good assets is another matter. The plethora of available data sources cuts both ways; while assisting investors, it also levels the landscape, neutralizing the competitive advantage traditionally derived from information asymmetry. If all it takes to find a deal is an internet connection and a LoopNet account—or getting on a broker’s mailing list—how does one create a differentiated sourcing strategy to find projects that will outperform?
Today, we’ll explore five strategies investors can use to find truly off-market deals with a focus on distressed opportunities. While some tactics require investors to get their hands dirty, we’ll also dig into how new technologies can help streamline and systematize deal pipelines, cutting down on manual work and ensuring the best opportunities float to the top of the pile.
State of the Market
Finding quality deals in today’s current market is a challenging endeavor. It’s old news that transaction volumes were significantly down across the board in 2023, which can be traced to several factors: high interest rates; pricing resets across commercial real estate; the general disconnect between seller expectations and buyer return requirements for investing. The list goes on. The upshot is that both sales of real estate and building permits were down significantly in 2023 (though still above the historic average since the 2009 GFC).
At the same time, the current environment seems like a good time to buy, with a significant amount of distress coming down the pike. In markets such as NYC, we have seen a sharp spike in office and commercial foreclosures due to the high interest rate environment. Similarly, we are seeing softening multifamily rents across the board caused by an oversaturated pipeline of deals over the past few years that will only continue into 2024 and onward.
While good opportunities are likely to emerge in the coming year, finding them is another challenge. When sourcing investments, I often consider this quote from Howard Marks: "If you seek superior investment results, you have to invest in things that others haven’t flocked to and caused to be fully valued." Finding things that aren’t properly valued is a major contributing factor to driving outsized returns. If one’s cost basis is forever, getting that number as low as possible demands capitalizing on information disparity to find those opportunities.
Notes on Finding Deals
Off-market deal sourcing strategies often generate the best deals, "distressed" and otherwise. But that isn’t to say that every off-market transaction you find will be a grand slam. It isn’t uncommon to meet off-market sellers with delusional notions of the value of their assets, and a brokered process often sets a more realistic bar for all parties. But securing outsized returns requires capitalizing on an information disparity between two parties in which either buyer or seller is unaware of the true underlying value of the asset. These are the moments where you see buyers either A) overpaying for a property at inappropriate valuations, or B) securing a deal at a below-market basis.
But finding off-market deals actually takes work and a systematic approach to secure opportunities on a consistent basis. The commercial brokerage industry exists to capitalize on connecting potential buyers with sellers in the marketplace – these important (and often sophisticated) middlemen save us all a lot of brain damage and heartache in helping manage the process of selling and listing deals. Yet broker participation often leads to the "magic" in a deal instantly disappearing. Brokers know the value of what they are selling, commanding the highest possible premium for their deals they can. By this point, any undiscovered value in a transaction has generally dissipated, and the asset has been "priced to perfection."
This brings us to off-market investment strategies. The below list is by no means comprehensive, as the strategies in sourcing off-market transactions can be as varied as there are investors. Provided here are methodical, reproducible strategies for both traditional and distressed real estate investing, outlining the pros and cons of each approach.
Off-Market Distressed Deal Sourcing Strategies
Broker Relationships
Prior caveats about brokers aside, brokers are often the first parties contacted by sellers at the outset of a sale process and are well-positioned to steer potential investors toward good opportunities—even before those deals are formally brought to market. By establishing strong broker relationships, trust as well as knowledge of investment criteria are built over time, so investors are more likely to see deals that are vetted and relevant to their acquisition criteria.
In a relationship-driven industry, this can be a major advantage. As an investor, this method does have the benefit of saving you the trouble of identifying deals yourself, though it’s perhaps just as expensive as a fully marketed transaction due to commissions and legal fees.
Direct Lender Relationships
In today’s environment, direct lender relationships can be a great source of distressed opportunities. It is not uncommon for banks to execute off-market transactions for speed and expediency on distressed deals with a trusted group rather than going through a protracted brokered process. With potentially souring deals on banks’ balance sheets, this is a good moment to reach out to one’s lenders and inquire if they might have deals to discuss together.
A key downside of this strategy is that you are dealing with an educated counterparty that likely understands the value of their own assets. While a potential bailout of a distressed deal might be attractive to both parties (be it through a recapitalization or an outright sale itself), unless the seller is in such a state of distress that they are forced to accept fire sale prices, you are likely dealing with a savvy, professionalized negotiating counterparty who knows what they’re doing.
Bankruptcy Courts
Bankruptcy courts are another compelling strategy to source off-market distressed opportunities. Services like Pacer Monitor, BK Data, or Inforuptcy allow investors to track bankruptcy filings nationally in the US, and can be utilized as an interesting sourcing methodology for undervalued deals. Of course, acquiring distressed deals in this context implies accepting a certain measure of risk – assets are generally acquired in "as is" condition, with no due diligence period provided to investors. While achieving a quick title check and some other high-level analytics might be possible, investors must be prepared to go into a deal virtually "sight unseen," with limited opportunity to verify other potential risks such as environmental, geotechnical, structural, etc.
In addition–with many larger or more desirable deals – it isn’t uncommon to encounter real estate owners who engage a broker or tee up a stalking horse buyer ahead of the actual bankruptcy court bid date. Thus, while bankruptcy courts can be a useful sourcing channel, assets are sometimes too far "downstream" to capture the value arbitrage that the intelligent investor is seeking. Although assets are trading at a discount compared to market, the participation of true real estate professionals in the transaction means the deal is often priced "appropriately" for the level of risk incurred, minimizing the undiscovered value proposition and increasing the likelihood of overpaying.
Contacting Owners Directly (Cold Calling & Mailers)
Lands End Capital has secured 12 industrial and 7 multifamily properties in the last 18 months through using direct mailer campaigns to source assets. This not only often results in favorable pricing but also establishes a direct line of communication between buyers and sellers, facilitating negotiations beyond just the price. The ability to extend closing dates, initiate renovations and leasing strategies during the closing period, and renegotiate a current tenant’s lease directly aids in overcoming obstacles, fostering direct contact to streamline the process and minimize potential miscommunication that intermediaries might complicate.
-Maarten Deschaumes, Lands End Capital
Colding calling and direct mailers are the two of the most fruitful strategies I have seen in off-market deal sourcing, which I’ve utilized with both my clients as well as for personal investing. But both require patience – they have the lowest conversion rate of all the strategies covered here, generating relatively few viable deals for the number of cold outreaches done. But they can also generate the best opportunities.
Direct outreach to owners involves securing data through more manual strategies such as combing through tax parcel information at the county level for owner mailing addresses. Services such as DataTree, RealQuest, or PropertyRadar can filter parcels by various attributes depending on an investor’s particular buy-box. These can include asset type, parcel or building size, and duration of ownership. This generates a list of properties and affiliated ownership entities, which serves as your basis for outreach.
From there, you can attempt either direct mailers (i.e. literal letters sent to a physical mailbox), emails (assuming the data is available at the county level), or cold-calling campaigns to reach out to the owners directly. There are miscellaneous services available (such as Mail Shark for mailers, or one of a plethora of cold calling services) to assist you with both methods in that process. Due to the ease, expediency, and low cost of a direct mailer campaign (usually at $1.00 per letter), this has been my preferred route of outreach. From there, one can establish a dedicated email, virtual mailbox, and/or virtual voicemail to receive inbound responses to your inquiries (often filterable and with transcription services for ease of processing). An investor now has a list of leads to comb through and evaluate as potential acquisitions.
The beauty of direct outreach is that an investor can more easily capitalize on an information disparity between themselves and the counterparty they are negotiating with. The real estate professional will likely have a better sense of the intrinsic value of the asset under consideration than the actual owner themselves, who simply lacks the knowledge to appropriately price their own property. This is also a great way to uncover distressed properties as well, as one can often be the first point of contact for the owner looking for an exit but doesn’t know who to initially call.
But there are several downsides to this strategy as well. Dealing with non-professional owners can lead to unrealistically high pricing expectations for the real estate they own (leading to an immediate dead end). In addition, your hit rate for letters or calls sent out will likely have a conversion rate of roughly 1-2% for simply getting a response, which is then further winnowed down to those deals that are truly viable.
Response timelines also vary – it is not uncommon to send a letter out and not hear back from that owner for several months (or even longer). For an individual to make the determination that he or she is interested in selling is not an immediate one and often takes time. Finally, the information arbitrage thesis still relies on having a relatively uneducated owner who doesn’t understand the value of the real estate he or she owns. This strategy is often more effective in sourcing from non-institutional owners than if your direct mailer lands on the desk of an asset manager at an investment shop.
In short, this method takes a decent amount of effort and patience to execute, requires a predefined buy box when sourcing owners to economize one’s time and resources, and generally generates better results when attempting to acquire from non-institutional parties. For the time sunk into searching for deals, it might simply be a more efficient use of one’s own energy as a professional to outsource your pipeline creation to a broker, or utilizing one of the other off-market channels previously suggested. Yet still, there is a potential for both upside and a cost effectiveness to this strategy that, in the long run, is usually much more effective that paying a commission to someone else. Using the example of a direct mailer campaign, if you spend $1.00 on a single letter, and mail out 1,000 for every individual deal that you derive from this process, your combined time and money spent on that sourcing likely costs you less than the 1-6% fee charged by a broker.
Parting Thoughts
There is no perfect off-market deal sourcing strategy that fits every investor’s needs. But by moving your sourcing as far upstream as possible – seeking out both information arbitrage and cutting out potential middlemen and competitors in the process – these strategies can be valuable tools for the savvy investor who is looking for a better way to acquire assets.
—Jonathan Andrews
Recommend Thesis Driven to the readers of Devon's wanderings
A deep dive into emerging real estate themes and the innovators capitalizing on them
 | A guest post by
|
Start Writing