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"Distressed" commercial real estate -- those assets that have gone back to the lenders or are saddled with other kinds of financial problems -- dot the landscape like dandelions on a May lawn. Their proliferating presence is hurting the Twin Cities market's sales velocity by skewing the expectations of would-be buyers and scaring off solvent potential sellers, local brokers say.

The exact amount of "distressed" property for sale in the Twin Cities is a matter of debate and is constantly changing. The definition is also a bit squishy. It could mean an office building, warehouse or retail center that is 100 percent bank-owned, or ones in which non-bank owners are offering a discount because they can't afford to perform needed upgrades and maintenance.

Nationally, the percentage of sales involving distressed assets went up in March. The CoStar Commercial Repeat-Sale Indices, released this month, uses a methodology in which the firm looks at properties that are sold more than one time, thus creating a "sale pair." The firm found that distressed sales as a percentage of the total sales pairs was 31.9 percent in March, up from 28 percent in February.

Sorted by property type, the highest percentage of distress in the first quarter was in hospitality at 42.6 percent, followed by office at 35 percent, retail at 30 percent, industrial at 28.4 percent and multifamily at 25.4 percent.

At the same time, it found that prices being fetched by office properties fell by 11.7 percent nationally in the first quarter

Meanwhile, Moody's/REAL commercial property price index found that 16 percent of all commercial loans to hotels and apartments are classified as delinquent, as were about 10 percent of loans on industrial properties and 7 percent each for offices and retail.

Locally, there's no shortage of properties on the market that have been categorized as distressed.

A search on the commercial real estate listing service last week revealed 41 "distressed" office properties for sale. They included such properties as the vacant, 50,000-square foot former Maxsun Furniture store in Elk River ($2.5 million); the Rush Lake Office Building, a newly built but never-occupied 20,000-square-foot structure in New Brighton ($2.5 million); and McAndrews Commons, a three-building Class B office complex in Burnsville ($1.95 million).

Other entries in the extensive "distressed" list include a vacant 17,700-square-foot Class A medical/office building along Hwy. 36 in Oak Park Heights; a 12,500-square-foot Class A office building in Chaska whose bank owners have reduced its price from $2.45 million to $1.65 million; and the historic, 1895-built Hinkle Murphy mansion in Minneapolis, which was converted to offices in the 1990s.

Many other properties are likely also "distressed" in reality, but not openly listed as such.

Local brokers say the highly visible presence of these properties is only adding to a perception on the part of buyers that they can scoop up well-located, highly-leased non-distressed properties at bargain prices -- a perception that for the most part is dead wrong, said Lisa Christianson of Christianson & Co. Commercial Real Estate Services in Edina.

"The bank-owned properties are just part of an overall mentality right now that's driving prices down," she said. "The general public just expects everything to be super-cheap, and the effect of that is keeping potential sellers from selling their properties."

With buyers seeing big discounts being offered by banks on repossessed properties, their expectations are unrealistic in terms of how much really desirable real estate held by non-bank owners is worth, and thus is stifling deal flow.

"Those that really have to sell are the only ones who are selling their properties right now," Christianson said. "It's all about the perception. What many people don't realize is that in most cases, there's a reason why a distressed property has gone back to the bank, so they're looking to pay nothing for good properties."

Peter Kordonowy, a broker for Summerhill Commercial Real Estate in Chanhassen, said the commercial real estate market is divided into two different worlds: the market for "core" or institutional-grade assets, which has potential buyers lined up around the block, and everything else.

"There's not a lot distress among these 'core' assets, like grocery-anchored shopping centers. There's a lot of capital out there chasing them," he said. "But with non-core assets, it's different. Sellers are getting dragged down by distressed real estate assets, without question. It's not the disaster that some had predicted, but it's a factor."

Kordonowy agreed that the unrealistic perceptions of great bargains to be had on top-notch real estate have made sellers reluctant to sell and is adding to the downward pressure on property values.

He pointed to his November 2010 sale of the 44,600-square-foot office/warehouse building at 7500 Equitable Drive in Eden Prairie for $2.35 million -- a building constructed in 1998 by Opus Corp. for Metro Printing. Its original sale price: $3.1 million.

"Every day I get blasted by ads for properties that are 'bank-owned,'" he said. "Owners are saying they don't want to sell if they don't have to right now."

Still, there are glimmers of hope. Despite the stiff headwinds, the "expectation gap" is steadily narrowing and can be bridged with a combination of psychology, counseling and skillful negotiation, said Dan Peterson of Adam Commercial Real Estate Services in Golden Valley.

"As much as the distressed properties, it's been about the downfall of prices from their peaks of several years ago, and the ability of both buyers and sellers to accept the 'new normal'" that has stymied the market, he said.

The plunge -- measured at 38 percent in the Midwest by CoStar -- has left sellers' as well as buyers' expectations unrealistic, he said. "Sometimes I have to ask them, 'Do you really think your property is worth what it was in 2005?'

Don Jacobson is a St. Paul-based freelance writer.

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