Recessions bring a number of challenges. Restricted lending, increased unemployment, and higher mortgage and rental defaults can lead to financially strapped property owners and investors. In the wake of the Great Recession, a term dubbed "rescue capital" made its debut as a way for the private market to step in, putting capital into purchasing distressed assets or providing real estate liquidity to distressed markets.
As the U.S. faces a recession as a result of the current pandemic, rescue capital is starting to make a comeback, with an initial focus on distressed commercial real estate and debt markets making it challenging for smaller real estate investors to find cheap deals in their markets.
If you're an opportunistic investor patiently waiting on the sidelines, learn what rescue capital is, how it works, and what it looks like in the marketplace today.
What is rescue capital?
Rescue capital is an injection of money into distressed markets and assets in the private marketplace. Rescue capital can be deployed by any investor, but in most cases the term is used to describe large firms, such as a private equity firm or fund, that will loan money to a company in distress either to help maintain company operations during challenging times or to purchase distressed assets, often at a discount, reviving the asset over time.
Rescue capital can provide liquidity to individual property owners and investors or large companies and financial institutions such as banks by acquiring or lending on hard assets like physical real estate or debt markets, including nonperforming loans. In both instances, rescue capital is intended to rescue the distressed markets, providing them with much-needed liquidity.
Why invest in rescue capital?
Rescue capital is an appealing investment option because of the potential discount or favorable terms the buyer can get during the transaction. The more the business needs money or the stronger the desire to offset the asset, the greater the discount or flexibility of terms is given.
Large rescue capital firms have the liquidity to buy in bulk and maintain the assets for the remainder of the recession until recovery is achieved. At that time, it's very likely values will have increased, payments will have been reestablished, or the assets will have been liquidated to recapture capital for the fund.
The fund can also gain access to a company as a lender through preferred equity, mezzanine financing, or other types of capital structure, such as a joint venture. This provides leverage and access to discounted real estate, often achieving higher returns for participating investors.
Risks and rewards of rescue capital
Rescue capital provides the necessary liquidity during tough economic times to achieve higher returns for investors, but it doesn't come without challenges. Rescue capital investors need to have a level of experience, expertise, and ample capital to provide liquidity to the fund. For example, purchasing and working out nonperforming loans can be both cost- and time-intensive.
The fund needs to be able to maintain operating and holding costs while satisfying their investors as they work through the loans, especially because collectibility on the investment is thwarted for a period of time. Government regulations and rules also add a layer of complexity to these asset classes, including increased reporting and audits.
Government intervention can only go so far. Not only is federal intervention through bills or other acts of Congress expensive but these measures often don't provide relief when needed, further proving that rescue capital serves a vital role in the marketplace. Smaller investors may see rescue capital as a hindrance, keeping distressed investments from flooding the marketplace, but it's unlikely rescue funds will be able to control the distressed market until full economic recovery is achieved.
Who is investing in rescue capital?
Right now, a number of new rescue capital funds are starting to surface. For example:
- The Broe Real Estate Group (BREG) just launched a $250 million Strategic Investments Program aimed at providing capital solutions to cash-strapped commercial real estate assets, including commercial mortgage-backed securities (CMBS).
- In January 2020, SoftBank Group (TYO: 9984), WeWork's largest investor, established a rescue package for $9.5 million in return for an 80% stake.
- Sortis (OTC: SOHI) launched a $50 million rescue fund for the acquisition of distressed loans and REO assets.
- Sun Mountain Capital launched a $100 million New Mexico Recovery Fund that provides direct financing to support economic recovery for businesses.
- Eastern Union also launched a distressed note initiative, a fund focusing on the purchase of distressed commercial debt.
While many funds are just getting started, those established and already in action could be pushing off the number of distressed assets that hit the market. However, without further financial support from stimulus bills and with the inability for economies to reopen fully, financial pressure will continue to build on companies, homeowners, and investors suffering from loss of revenues or income.
Landlords, investors, and borrowers will feel the impact, especially now that the eviction moratorium is extended through the end of 2020, meaning it's very likely more distressed assets will make their way to the market.