Types Of Distress That Create Value For Investors

….and others that can destroy it

by Christian Macellari

Distress is everywhere in real estate right now. Every week another fund launches to chase distressed properties and “special situations.” I get it. Commercial real estate, and multifamily especially, has taken four hard years since valuations peaked in 2022. But the word gets thrown around loosely, and not all distress is the same. Some of it hands you a generational entry point. Some of it will bury you. Knowing which is which is the whole job.

Rewind to the post-COVID Sun Belt, where investment activity and pricing ran hottest. Rents posted record gains, with Phoenix and Tampa seeing asking-rent growth of around 20% year over year and Miami running closer to 30%. Cap rates compressed to lows nobody had seen, which is just another way of saying investors were paying more and more for every dollar of income a building threw off. By the 2022 peak, per-unit values across the Sun Belt sat roughly 20% above 2020 levels, per CoStar.

Three Things Drove That Run:

• First: Rent Growth

Investors watched 2020-2021 rents jump and figured it was just the start. Work-from-home, people leaving dense cities for the suburbs, all of it would keep pushing suburban rents higher. It worked for a while. Then it reversed, and that reversal set up a lot of the distress we’re seeing now.

• Second, Cheap Money

From 2020 to 2021 the 5-year Treasury averaged about 0.70%, the lowest on record. Borrowing was cheap, underwriting got loose, and a mountain of deals got done on 3-year bridge loans. Cheap debt on top of loose underwriting was the same setup that blew up in 2007 and 2008, just dressed differently. The bet was simple. Buy something renting below market, spend to fix it up, push rents, then refinance or sell at a profit before the loan came due. That’s value-add investing, and it carries a lot more risk than buying a property that’s already stabilized. The plan had to work inside three to five years, or the math stopped working.

• Third, People Moved

Florida pulled in about 319,000 net domestic migrants in a single year, and Texas gained more residents than any state, all chasing lower taxes and a remote-work life that let them live wherever they wanted. Maricopa County alone added nearly 57,000 people, the biggest one-year county gain in the country. On the other side of that shift, high-tax, high-cost states bled residents, with California, New York, and Illinois losing the most. All of it poured fuel on housing demand and rent growth across the Sun Belt.

Now look at today. Rents have softened across the Sun Belt and properties are scrapping for tenants. Some are handing out up to three months of free rent just to fill units. All that 2021-2022 demand kicked off a building boom, and those units are delivering into negative rent growth, higher rates, and migration that has slowed. Values reset hard. Some markets are down as much as 27% from the 2022 peak and now sit around 20% below it, according to CoStar.

Sounds like doom and gloom. But history rewards discipline, and the supply picture is already turning. Deliveries have dropped sharply from their 2024 high, the construction pipeline has shrunk by roughly half since early 2023, and CoStar expects demand to overtake new supply by early 2027, with vacancy easing and rents firming after that. The oversupply pressuring rents today is temporary. That’s exactly why a disciplined, low-basis entry can pay off.

Good Assets Caught In Distressed Situations

Here’s the distinction that matters most. There’s a good asset caught in a distressed situation, and there’s an asset that’s genuinely distressed. Most of today’s pain is financial, not fundamental.

The best opportunity is the good property bought at the wrong time. An operator buys a solid asset near the peak, puts in capital, stabilizes it, then watches headwinds drag rents below plan. If the deal was financed with a bridge loan now maturing into the highest rates in years, refinancing may be off the table, and the owner sells at a discount or hands the keys back to the lender. When that property sits in a strong pocket where demand holds and the softness is just temporary oversupply, a three-to-five-year hold can reward patient capital.

The opposite case is when the asset itself is the problem. Submarkets hit by crime, or where household incomes just can’t support the current rents or the business plan to increase rents.  These assets tend to keep underperforming no matter what the price of the asset is. Those situations only work for investors with long horizons and deep enough pockets to sit through years of weak performance. The typical buyer won’t create value there.

Telling those two apart is the whole game right now.