Buying a distressed property? Here’s what you should know.

Distressed Property

What is a distressed property?

Although rare, a distressed property is one where the owner has borrowed against property to acquire the asset and has not been able to repay his debt obligations. If the borrower fails to service the loan for 4-5 consecutive cycles, the property is seized by the bank as collateral. The lender bank then sells the property to recover its outstanding interest and unpaid principal amount. Such a property is sold through a bank auction and can be acquired at prices which are often well below market value.

However, less than 5% of Indian borrowers default on repayment of a loan for periods long enough to permit a bank auction. Moreover, there is limited scope for getting such properties at throwaway prices, as the base price for the auction is determined by the loan amount outstanding which means that if the owner is far ahead in the loan term, the lower the base price. Hence, owners who have only a few cycles left to settle off dues would prefer to restructure the loan rather than default on payment.

Sale of distressed property – how to know?

As a custom, banks release an advertisement in leading local newspapers when they propose to auction off a property or set of properties. So, this is the best source of information. A bank’s annual report always mentions a provision for bad debts, and the schedules/annexure reflect if and when any distressed properties will be coming up for auction.

You can also contact a property consultant with expertise in the location and enquire about distressed asset opportunities in the area. The property advisor can also represent investors in discussions with the original owner or directly with the bank.
Sale of distressed property – the process

When a property is positioned for auction, it is advisable to read the bid document vigilantly to understand the status of unpaid dues. The bid document is like a prospectus of an IPO where all the facts pertaining to legal, title and responsibility for pending dues are outlined. Most of the time, the property is sold on a ‘as is where is’ basis and till the date of auction, loan obligations are cleared.

Between purchasing a distressed asset through a real estate advisor or local enquiry and bank auction, the latter is a lengthier process as the bank will first release an advertisement, set a date for the auction, invite bids, collate the offers and then finalize whom to sell the property. It becomes more cumbersome if the buyer himself plans to acquire the property on loan. The bank conducts a thorough due diligence search on the incoming buyer and then draws up contracts to transfer the property along with a go-ahead from the owner and a society NOC making the process even more time-consuming.
The bank has to obtain an NOC from the society before conducting the auction. Many societies and their members have first right of refusal along with the right to match the highest bid to buy property. The society highlights any liabilities that the new owner will have to bear. These aspects are captured in the bid document by the legal council of the bank and the bidder can refer to them to assess the exact liability.

When the distressed property is being directly purchased from the owner, both parties (original owner & new owner) agree on the commercial terms, exchange a token deposit and then complete the bank process to proceed with the purchase. The entire process of releasing the property by the bank, granting the NOC and procuring NOC from the society in addition to clearing off the bank dues may take nearly 2–3 months. The price in this case is therefore usually higher than it would be in a bank auction, since the seller tries his best to recover as much of his initial investment.
To conclude, any buyer who wishes to purchase a distressed property must be fully aware of what he is getting in to. Exercise precaution by carefully reading the bid documents, understanding the history of the property under discussion and also get historical papers for title due diligence to avoid any legal challenges in future.