Investing in Distressed Commercial Real Estate: Strategies for Success

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Guest Contributor

April 11, 2024

A dilapidated building with grafitti stands adjacent to another older, concrete building

From abandoned warehouses to empty strip malls, there are plenty of examples of distressed commercial real estate across the U.S. Investing in these properties can be a lucrative part of a balanced real estate portfolio. Here are ten strategies for success when you’re looking to invest in distressed commercial real estate.

What is Distressed Commercial Property?

Distressed commercial properties are under such financial strain that foreclosure may be on the horizon. These dire economic straits may arise due to an owner's inability to pay their mortgage, but that's not the only reason properties become distressed. Improper building maintenance can lead to deterioration, legal challenges, and other environmental factors that may cause stress that leads to a property becoming less viable for the owner.

Why Invest in Distressed Commercial Property?

As with any real estate investment, distressed commercial property comes with its own risks and challenges. However, a variety of positives make these an attractive proposition. They include:

Cheaper acquisition costs
Opportunities for value-added investment (i.e., repositioning, renovation, or redevelopment)
Solid returns
A more diverse investment portfolio
Potential for long-term growth

Colorful older apartment buildings sit on the corner of an old street

10 Strategies for Distressed Commercial Real Estate Investment

It is important to note that the property you are considering became distressed for a reason. That said, there are ways to take a flailing commercial property and turn it into a lucrative investment. Here are ten strategies for success.

1. Do Your Due Diligence

This first step is the most important one to take. Conduct comprehensive research and due diligence on any distressed commercial property you are considering. Look at the location, its condition, market trends, and the potential for renovation or redevelopment.

You will also need to look at outstanding debts. This includes liens against the property and any pending legal issues that transfer to a new owner. Crexi Intelligence is a handy aggregator of this data and more, key for making any investment decisions.

2. Time the Market

Pay careful attention to your timing when investing in distressed commercial real estate. Examine key economic indicators and property market trends to determine whether now is the right time to acquire a commercial property. However, timing can be tricky — you want to weigh holding for the right time against missing a potential opportunity.

The New York City skyline with the sun setting behind the skyscrapers

3. Consider Partnerships and Joint Ventures

First-time investors in commercial real estate should consider forming partnerships or joint ventures with more experienced investors or developers. It takes the financial burden off a single investor and can mitigate the risk. Experienced investors and developers have resources and expertise that can be valuable. They also bring access to capital and a professional network of contractors who can help with construction.

4. Consider Adaptive Reuse

If your interest in distressed commercial real estate doesn't match what's available, consider adaptive reuse of properties. This strategy converts underutilized buildings into properties with alternative uses that fit the current market better. Potential adaptive reuse includes mixed-use development, coworking spaces, or other creative office areas.

The words "Drive-In Theatre" are painted on an old wooden wall of a building.

5. Highlight Value-Add Opportunities

Distressed commercial properties that are solid and well-suited to their purpose can still be an excellent value-add proposition for investors. Renovating outdated buildings, repositioning the property, or improving its management efficiency can increase the property's value over time.

Value-add opportunities also include making energy efficient and environmentally friendly changes and improving currently underutilized spaces (e.g., a dark courtyard transformed into a casual outdoor gathering space).

6. Negotiate Favorable Terms

The best deals are made at the negotiation table. The price of a distressed commercial property is just a starting point. There are many ways to improve your investment position, including offering a lower price, negotiating all or partial seller financing, or structuring a deal with contingencies. These contingencies include property improvements made by the owner before the sale.

Water-stained outer side of a old multifamily building

7. Secure Strong Financing

If the seller does not finance your purchase, you must secure strong financing that works to your advantage. Favorable terms better support the acquisition of the property and any renovation or operational costs you might incur.

Consider options like bridge loans, hard money loans, or private equity investments. As you look for potential financing, ensure the structure fits your investment goals and tolerance for risk.

8. Create an Active Management Plan

Few first-time distressed commercial real estate investors can succeed with a hands-off approach. Implementing proactive management strategies can address issues and maximize the potential return.

This includes overseeing renovations, identifying and recruiting tenants, renegotiating existing leases, and developing a plan for more efficient operation. Being involved in the day-to-day management of your property can help stabilize it and enhance your long-term return on your investment.

9. Diversify Your Commercial Portfolio

Remember when the pandemic sent retail outlets reeling as shoppers stayed home and purchased online? So do commercial real estate investors with portfolios full of retail properties. Yes, distressed commercial real estate adds diversity to your portfolio, but there can be diversity within this category, too. Think retail, warehouse, and industrial space, among others.

10. Plan Your Exit

What is your goal in investing in distressed commercial real estate? Do you want to hold on to the property long term, generating regular rental income, or are you planning on selling it for a profit after renovation? Having goals for the investment drives your decisions and can maximize your returns.

A corner of a multifamily apartment building in Louisiana's French Quarter

Where to Find Distressed Commercial Real Estate

Some distressed commercial real estate is easily visible from the side of the road, with large signs indicating its availability for sale. But the best bargains are often hidden, accessible only to those willing to dig for them.

When starting your search for distressed commercial property, here’s where to look:

Websites: Commercial real estate investing websites may have special sections for distressed properties.
Brokers: Some real estate agents specialize in commercial property, and some drill down even further to distressed commercial real estate.
Lenders: Lenders are an excellent resource, as they become aware of distressed properties sooner than the average investor.
Investor networks: If you are partnering with another investor, chances are they have a network that can provide word-of-mouth leads on potential properties for sale.
Targeted marketing lists: Targeted marketing identifies specific buyers and sends only those properties that match their criteria.

Finding a distressed property that meets your investment goals can take some time, so be persistent.

The Bottom Line: Should You Buy Distressed Property?

All investment comes with risk. The only way to determine if buying a distressed commercial real estate property is a good investment is to carefully weigh the pros and balance out the risks.

Ben Mizes is the Co-Founder and CEO at Clever Real Estate, the nation’s leading real estate education platform for home buyers, sellers, and investors.