In August 2012, an affiliate of Alliance Partners HSP, LLC, (“Alliance”) acquired the first mortgage loan (the “Loan”) encumbering a 68,000-square-foot, Class A medical office building known as the Crystal Lake Medical Center (the “Property”) located in Suburban Chicago, Illinois. The $8.1MM acquisition was closed with 100% equity. The seller was a regional bank (the “Seller”) that had made the loan to finance the construction and stabilization of the Property. The borrower of the Loan was a regional developer (the “Borrower”) that completed construction of the Property but only leased it to 48% occupancy. Due to the low occupancy and deterioration in market conditions, the Borrower could not refinance the Property upon Loan maturity and defaulted on the Loan. The Seller did not want to own a distressed Loan and sought a quick disposition at a discounted price (i.e. less than the unpaid principal balance on the Loan).
Acquisition - Alliance’s “base case” plan in acquiring the Loan was to gain control of the fee simple real estate, either by means of a deed-in-lieu of foreclosure or a foreclosure. Once in control, Alliance could utilize its operating capabilities to stabilize the Property. Alliance was prepared to undertake the foreclosure process if necessary, even though that process could take 1-2 years. By contrast, the typical purchasers of distressed loans are hedge or private equity funds (the “Funds”) that do not have real estate operating capabilities. Consequently, Funds are more interested in acquiring loans at a steep discount to (ideally) negotiate a quick discounted payoff by or other form of settlement with borrowers and never take operating control of properties. Since Alliance was not reliant on a discounted payoff strategy and would be happy to own the Property, Alliance was able to pay slightly more than traditional Funds. Conversely, most real estate operators cannot acquire loans as a means to acquiring real estate, eliminating competition from a subset of potential buyers. In short, Alliance’s flexibility as an investor/operator uniquely positioned it as the “logical buyer” for the Loan and allowed it to win the acquisition at an attractive basis. The Seller wanted to sell the Loan quickly so it could recognize the loss on the Loan (given that it was being sold at a discounted to book value) during a certain month. However, this meant that Alliance would have to complete due diligence and close on the acquisition within three weeks from letter of intent execution, a highly expedited process for any real estate transaction. Given that Alliance is an entrepreneurial organization that does not require a long-lead time to call capital from its high net worth partners, Alliance was able to meet the Seller’s expedited time frame.
Disposition – After acquisition, Alliance approached the Borrower to seek a deed-in-lieu of foreclosure. Unpredictably, Alliance received notice from the Borrower’s capital partner (the “Capital Partner”), that (1) the Capital Partner had taken full ownership of the Property from the Borrower; and (2) the Borrower was interested in acquiring the Loan in a discounted payoff. After initial negotiations, the Capital Partner submitted an offer to acquire the loan at a premium to Alliance’s acquisition price. However, Alliance believed that a higher price was justified and responded with a comprehensive underwriting of the Property that supported a higher valuation for the Loan and demonstrated Alliance’s willingness to foreclose to realize the full Property value, if necessary. This compelled the Capital Partner to increase its bid, and a sale was consummated at a material profit. Alliance willingness to foreclose and act as an operator strengthened Alliance’s negotiating position with the Capital Partner and allowed Alliance to achieve a better result.