Distress Sales Dominate the Market : Real estate: Most of the commercial buildings changing hands this year will be in foreclosure or about to be, brokers surmise.

All is quiet on the commercial real estate front. Lenders aren’t lending, and developers aren’t developing.

About the only sound you hear these days is the stampede of financially strapped building owners scurrying to sell property that has become burdensome and ungenerous.

While the late 1980s are eulogized as the red-letter years for Orange County real estate, the early ‘90s will be mourned as the red-ink era. Brokers here surmise that at least three-fourths of all building sales in 1992 will involve “distressed property”--sites that are either on the road to foreclosure or have already been claimed by their lenders.

“This will be the peak year for distress sales,” said George Economos, a senior vice president in the Newport Beach office of Grubb & Ellis.

Although no one keeps firm statistics, brokers estimate that distressed property accounted for only about 10% of transactions two years ago. That figure took a leap last year, but still came in at well under 50%.

Why will 1992 be so skewed toward deals grounded in desperation? The answer is relatively obvious. “People aren’t selling unless they need to,” Economos said.

Prices are at rock bottom--as little as half what the same buildings would have gone for only two years ago. So investors who can afford to wait out this awful market aren’t budging.

Richard Stenton, president of Mission Equity in Laguna Hills, did not have that option when the note came due on one of his prized possessions--a two-story office structure in Mission Viejo. “Our building is a good example of what a lot of developers are facing today,” he said.

The building, which sits on a prime spot at the intersection of Alicia and Marguerite parkways, has a lot going for it. The second-floor offices, for example, have a view of Lake Mission Viejo. Before its completion, the attractive building drew a couple of small companies into leasing its entire 22,700 square feet.

But the building had one fatal flaw: its birth date. It came on the market in 1990, on the wrong side of the boom.

“We just happened to build at a bad time,” Stenton lamented.

So bad that Security Pacific Bank, with whom Mission Equity had enjoyed a long and successful relationship, refused Stenton a permanent loan on the building. The bank had funded the building’s short-term construction loan in 1989, back when lenders still harbored affection for real estate. But only one year later, developers woke up to a cold new world.

“We owed our bank $3.1 million, and the best permanent loan we could find was for $2.1 million, due to today’s conservative underwriting,” Stenton said. “We would have had to come up with $1 million out of pocket, so we had no choice but to sell.

“Who would have ever thought that we’d need to sell a fully leased building?” he mused. “It would have been a nice property to hold onto.”

Fortunately, the building attracted a buyer in January, only a few months after the “for sale” sign went up. “We were able to rid ourselves of the possibility of having the bank foreclose on it,” Stenton said. “A lot of people in these situations have been forced to go into Chapter 11 (bankruptcy).”

What’s more, Stenton managed to sell the property for the nearly break-even price of $4 million--quite a feat in today’s market. A San Marcos family trust bought the building as an investment. “They weren’t just bargain hunters looking for problem property they could get at a big discount,” Stenton said. “They wanted quality and a good location.”

In its 13 years of developing more than 150 office and industrial sites, Mission Equity has never experienced such a blow to the ego, Stenton said.

“We have always been able to obtain money,” he said. “This (the virtual freeze on loans to developers) just took me completely by surprise.”

John Frazier, until recently a broker with Sperry Van Ness in Newport Beach, represented the buyer in the sale of Mission Equity’s building. The deal, he said, exemplified what in 1992 will be the typical commercial real estate transaction: a distress sale of a small building.

“1991 was a year of denial, on behalf of developers and investors who are in over their head from buying overpriced properties in the late ‘80s,” Frazier said. “1992 will be the year that those people will face the reality that they have to divest themselves of those properties. The primary driving force in the market will be distress.”

Most of those sales will fall in the under-$5-million price range, said Frazier, who left Sperry Van Ness last month to join Paragon Decision Resources, a real estate advisory service in Irvine.

“We haven’t been seeing many of the $8- to $20-million transactions lately, because the bigger player is out of the market right now,” he said.

Large properties “are in the hands of deeper pockets,” noted Economos of Grubb & Ellis. “Insurance companies, pension funds and foreign investors tend to own those developments,” he said.

“Developers, syndicates (groups of investors), and owner-users tend to be the smaller investors who might not have the money to wait,” Economos added. “They are in the riskier position.”

A CB Commercial Real Estate Group survey of $1-million-plus transactions shows that smaller properties composed the bulk of distress sales last year. Of the 87 distress sales tabulated in Orange County, 55% involved buildings in the $1-million to $3-million price range, and another 31% were in the $3-million to $6-million range.

The survey counts a total of 87 transactions, 10 of which were distress sales. But it does not include buildings under $1 million--an area that will be riddled with distress sales this year, said Joseph Leon, investment specialist at CB Commercial in Newport Beach.

“Pension funds and other big investors are staying on the sidelines until rents go back up,” Leon said.

Nowadays, even well-leased buildings don’t always carry their weight. Because landlords have had to slash rents to remain competitive, many buildings--especially newer ones--aren’t bringing in enough money to offset debts. “The (leasing) market is off 25% to 50%,” Leon said.

That phenomenon has fanned the proliferation of distressed property.

“As lease rates go down, net income goes below monthly debt service,” Economos said. “Most people can only take so many months of negative cash flow.”

Yet another factor in the explosion of distress sales is the Resolution Trust Corp.’s appearance on the scene. The federal agency, created to take charge of failed savings and loans, has inherited billions of dollars worth of properties that it must unload--often at a price that deflates the entire market.

“We’re seeing the RTC sell properties at half of what they would have sold for 10 years ago,” said Lawrence O’Brien, a founding partner of Lee & Associates Commercial Real Estate Services in Irvine. “The RTC has its own agenda. It needs cash; it needs to dispose of the property.”

While many people in real estate are keeping busy with lots of small, distressed transactions, the pay isn’t as good and the work isn’t as rewarding, they say.

“Our commission gets squeezed more often because deals don’t go through any other way,” Economos said. “The broker has to decide whether he wants 4% of nothing or 3% of a little more than nothing.”

A down market “just isn’t much fun,” said John Adams, a Newport Beach real estate appraiser. “Now much of my time is spent dealing with lenders and borrowers in adversarial positions.”

Moreover, Adams said, there’s little enjoyment in telling clients that a property’s value has dropped by 50% over the past two years. “Some aren’t prepared for the news,” he said. “Again and again, I hear: ‘That can’t be right.’ ”