For lenders unprepared or uninterested in managing distressed property, a receiver may be worth their weight in gold—or a massive headache.

A deed in lieu might seem like the quickest path to repossess a real estate asset. The process offers a relatively swift way to reclaim property, immediately adding value (albeit in a non-liquid form) to your balance sheet. However, the allure of expediency often masks the underlying challenges. Properties acquired through deeds in lieu may not be fully leased, or they may require the builder to add finishing touches.

A more strategic approach might involve receivership. By appointing a receiver to manage the asset, owners can potentially maximize the asset’s value through operational improvements. Although the financial performance may not match pre-distress projections, a functional, operating site is generally more attractive to buyers. The ultimate goal is to optimize the property, sell it, and recoup some of the initial investment.

Let’s consider a hypothetical case study involving a  medium-sized multifamily apartment site. As the private lender, you have a good rapport with the owner, who is also the builder. The guy is doing his first development project, believes in its success, and lives on the property. A few units have yet to be polished and punch lists aren’t completed, but the building has its certificate of occupancy, and all other units are finished and slowly leasing up.

But now the contingency you planned for but hoped to avoid is a reality. The broader market (specifically this local market) has shifted substantially, and the asset you’ve invested in has failed to live up to its estimates.

Originally this asset was to be a shining light in your portfolio: It hit the right market at the right time with the right rents for the targeted audience. Now, due to permit delays, labor and materials increases, and a job market that fell flat in the region, the property is falling grossly short of the pro forma upon which you based your investment decisions. You’ve nurtured the owner and the city, but it’s time to bring in some alternative options as no loan payments will be paid for the near future. What’s next?

Research Your Options

Having a conversation with a trusted broker may be a good discussion to start on the side. Doing so gives you a picture of the market outside this specific property and allows you to build a 5-year pro forma that would indicate what a hold could look like versus an optimized sale versus a deed in lieu. It is clear your borrower is paddling hard against the current, and you’re being pulled along for the ride. Ultimately, this means that in its existing form, the property will be unable to carry itself with the current rent roll. Lender distributions from operational funds are nonexistent.

Armed with some information about your specific property as well as the marketplace, you call your legal counsel. It’s time to start a challenging process to recover your funds to the extent possible. As a savvy creditor rights advocate, your attorney has several possibilities for you that you’ve reviewed in theory. After your conversations, it’s clear that a receivership may be the best way forward in this situation.

A receivership is a tool that more and more states are encouraging, applying a legal principle that gives a property one final chance to revive and operate before a state of bankruptcy or foreclosure occurs. You’ve reviewed the pros and cons with your team considering the time, expense, and legal fees that would be required to execute. The difference in the sales price of the asset ultimately tips the scale in favor of the receivership. The increased price of a stabilized asset means that the time, expense, and legal efforts would be ultimately worth it.

A Solution

Opting to proceed with receivership, your attorney begins drafting documents. As a private lender, you’ve had to deal with prickly debtors and delayed payments, but this is the first time you’ve entered a receivership. A call to a few trusted colleagues quickly shows that you are not alone in this; in fact, it’s becoming increasingly common. You get a few names of receivers that were liked, also some that were not. What qualities should you be looking for?

Your receiver should have extensive experience in the local market, a history in development or construction, and a deep knowledge of asset class stabilization and sales. The receivership team or individual will step in to relieve the debtor of operational responsibilities. Thus, the receiver will be required to step into construction completion, bring up rental comps for analysis, and optimize the units already leased. This all happens concurrently while operating on a shoestring budget. Your attorney advises that in the first month or two, you may be required to put in operating funds–this ensures that projects are completed and utilities, etc., are paid to continue the optimization of the asset.

What else? The attorney advises you that the receiver is to be independent of any of the parties associated with the asset. Although the receiver may take opinions or have discussions with the lender, lien claimants, the owner, or the lender’s counsel, the receiver will keep their own course based on their assessment of the property. They will be appointed by the court to preserve, protect, and stabilize to the highest point possible.

Releasing the reins is a bit daunting for your lending team, but the knowledge that the receivership is in place for the best interest of the property is a comfort. Receivers don’t represent the debtor or the lender. They even retain their own legal counsel. This further protects their independence, without pressure from either side.

What to Expect

After the receiver is appointed, they will review the court order to identify any restrictions or special instructions. From there, the operational aspects will take over. Obtaining access to current bank accounts, setting up a separate trust account for operations (accessible only to the receiver), obtaining upfront operating funds if necessary, and, in certain cases, procuring a bond.

The receiver will have interviewed and chosen a property manager for this asset. That manager will be able to collect rents, change locks/keys, handle tenant communications, and document the current condition of the property. They will have access to all the utility accounts to ensure they are kept current—this includes water, sewer, gas, electric, etc.

On the construction side, the receiver will make note of any violations, permit status, and subcontractor mechanic liens. This will allow them to finish the work (whether with the current builder or another general contractor) to complete lease up as expeditiously as possible. Coordination with the property manager facilitates a timely marketing pitch so that the unit can be occupied as quickly as possible upon completion.

Your finance team will easily be able to track receiver actions on the property with the detailed reports that will be produced monthly. The receiver will have the ability to act immediately upon appointment to take over any available funds, contracts between owner/vendor, and insurance policies. All accounting records will be placed with the receiver, who can set up a budget or forecast for the property, month by month. They’ll be providing regular financials to the court (i.e., P&L, balance sheet, rent rolls, and estimated disbursements).

Though they are consistently acting independently, you can be briefed on all of these items as long as it’s not deemed a conflict with the plans for the property. The situation will start to stabilize, and your contact with a trusted broker will become increasingly pertinent. Obtaining BPOs along the way will allow your projections to show a realistic sales price, rental pricing outlook, and NOI. You’re on your way.

Receivership is a tool, not a cure-all. You should analyze whether the potential benefits justify the time and expense. A court-appointed receiver can be a valuable asset, but it’s important to use them strategically.