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Washington Business Journal

Friday, June 3, 2011

By Sarah Krouse

The secrets of off-market deals – for some real estate companies, hitting the pavement is the best way to strike a deal

For Mark Schacknies, chasing off-market deals is grittier, dirtier and, frankly, more fun than biding on widely advertised properties.

The founder of Fairfax-based Walnut Street Development is one of many local developers and investors who thrive on off-market transactions, the kind of deals that don’t get featured in glossy pamphlets or advertised by big brokerage houses.

It’s a business that requires plenty of insider connections.  Finding and pursuing such deals involves a mix of scouring classifieds, digging through land records, calling banks and tracking a property over its lifetime—waiting for the prime moment to step in and acquire anything from buildings and the land the sit on to the debt behind them.

“Typically it is just feet on the street walking a neighborhood, trying to learn who’s on first and then getting a sense for who the players may be,” Schacknies said.  “A lot of deals I find are buying other people’s mistakes.”

Schacknies—the force behind residential projects such as the Rainbow Lofts on Church Street, Clarendon 1021 and Old Town Village in Fairfax—searches the market for small apartment projects as well as single-family homes and townhouses that can be repositioned and sold.  He’s focused on smaller properties right now.

“It’s easier to sleep at night knowing you can do the map on the back of a napkin,” he said.  “A lot of it is intuition.”

Putting a number on a percentage of deals that fall into the “off-market” category is tough.  Research companies that track building sales do not keep records on how properties were marketed, so much of the effort to gauge the size of the off-market world often comes down to anecdotal evidence.

Still, there are local companies regard off-market deals as their bread and butter.  Take Rock Creek Property Group, which generally does less than a handful of deals each year but focuses almost entirely on properties that are not widely marketed.  The stories behind the deals rarely come out, but often involve persistent, private meetings and a lot patience.

Rock Creek January acquisition of 1438 U Street, NW for $2.75 million, or $229 per square foot is a good example.

The 12,000-square-foot historic bank building that hosted the Station 9 night club came to market in a spring 2010 foreclosure auction but didn’t fetch high enough bids.  Rock Creek principals attended the auction but didn’t make an offer.  Instead, they approached the bank later.

A nonprofit group got its foot in the door before Rock Creek, but the organizations deal fell through and the bank assigned the foreclosure to Rock Creek in December.

Bigger companies such as Federal Capital Partners also spend time chasing off-market deals, though that’s only about twenty-five percent of the Georgetown company’s business.  It only makes financial sense for the company to go after deals that are worth more than $15 million and involve about $5 million in equity, and most of those deals are listed with brokers, FCP principal Lacy Rice said.

“A growing percentage of real estate in Washington is owned by financial institutions and the people who run those, whether it’s a fund or insurance company or overseas entity, virtually all of them have a fiduciary obligation to get the highest price when they sell,” Rice said.  “The only way you can be assured of the highest price is to broadly market the asset.” 

Federal Capital Partners bid for a 172-unit apartment building near the Fort Totten Metro station in a winter foreclosure auction that the company saw advertised deep in the classified section of The Wall Street Journal.  Only one other bidder went to the auction, taking the building for about $50 million.  Rice said the seller could probably have fetched a higher price had it broadly marketed the property.

With a glut of troubled loans and properties on the books nationally, banks often don’t have the time or the staff to broadly market smaller properties, Rice said.  That means aggressive companies can get a leg up by finding distressed properties on their own by cold-calling, perusing loan list through online data services or working long standing relationships within financial institutions.

“It’s mostly knowing the deals that need money.  We watch them.  We saw them get overleveraged, and we make it a point to try to look at most major transactions and understand who the buyer and sellers are and how they are financed,” Rice said.  “We call the lender and call the borrower, and over a three-to four-year period, they say, ‘We’ve run out of hope’.”

That’s when FCP steps in.

Not all off-market deals are the product of distress but many are although the Washington area has not seen the amount of troubled loans that many in the development world had braced for when the recession hit.

The volume of distressed real estate in the Washington area was up to $8.2 billion in April 2011, from $3.3 billion in January 2010, according to Alexandria-based real estate company Delta Associates.  Washington had the fourth-highest volume of distressed real estate among the top 10 metro areas but is in far better shape than markets such as South Florida, Atlanta and Los Angeles.

Josh Adler’s LaKritz Adler Real Estate Investments is among the local companies that continue to pound the pavement for the one or two opportunities to buy a property or development prospect that has emerged as a result of events such as a family wanting to shed an asset, financial problems or sellers that don’t want to pay a broker.

But Adler is not sharing the recipe for his success.

“It’s a vague subject, and one I’d be surprised if anyone other than Donald Trump would go on the record with details about, unless they are retired,” Adler said.