Course 6: Distressed Assets and Non-Performing Loans
Distress is where commercial real estate is mispriced, and the lender decides when it trades. This course teaches the bank’s side of the table: how troubled loans are classified and written down, when banks sell notes or property, and how to price a non-performing loan.
By Michael R. Linton, Florida Broker #BK703722 · October 21, 2026
Think Like the Bank
Every distressed deal is decided by the lender’s numbers. Learn to read them, then price the note or the REO yourself.
Most commercial real estate is priced by buyers and sellers. Distressed real estate is priced by lenders, under rules most investors never see: how a loan is graded, how much the bank has already written off, and what a sale would do to its capital. Learn those rules and you know which deals can actually trade, and at what price.
The case study used in this course
A community bank holds a $2,000,000 commercial loan at 7% on a Central Florida retail strip. The borrower has stopped paying, and a broker price opinion puts the property’s as-is value at $1,550,000. The figures are hypothetical, but the mechanics are how these loans actually move.
Lesson 1. Why Distress Is Mispriced
In a normal sale, the seller wants the highest price and can wait for it. In a distressed sale the real decision-maker is often a lender with different goals: reduce problem assets, protect capital, satisfy examiners and close the file. That creates opportunities you cannot find in normal markets, but only for buyers who understand what the lender needs. Our Market Map tracks commercial distress transfers and bank-held parcels by county and ZIP code, so you can see where pressure is building; see the Leesburg market update for an example.
Lesson 2. How Banks Classify Troubled Loans
Federal bank regulators use common grades for credit quality. Knowing where a loan sits tells you how much pressure the bank is under to act:
| Grade | What it means | What it means for a buyer |
|---|---|---|
| Pass | Performing, acceptable risk | Not for sale |
| Special mention | Potential weaknesses that deserve attention | Watch list; early conversations only |
| Substandard | Well-defined weakness; possible loss if not corrected | Workout, modification or note sale candidates |
| Doubtful | Full collection highly questionable | Strong sale candidates once written down |
| Loss | Uncollectible; charged off | Already off the books; pricing driven by recovery |
Loans 90 days or more past due, or on nonaccrual, are generally called non-performing loans. Banks report these figures quarterly in public call reports, which is one way to see which institutions are carrying problem assets. Within a bank, these loans move to a special assets group whose job is to resolve them.
Lesson 3. Write-Downs and Carrying Value: Why Banks Can’t Always Sell
When a loan depends on its collateral for repayment, the bank measures expected loss against the collateral’s fair value less costs to sell, and records an allowance or charge-off for the difference. In our example, the property is worth $1,550,000; less 10% selling costs, that is $1,395,000. Against a $2,000,000 balance, the bank writes down about $605,000 and carries the loan at $1,395,000.
That carrying value is the number that matters. A sale at or above it closes the file with no new loss. A sale below it forces another loss in the quarter it happens, reducing capital. This is why a banker may say “not yet” to a reasonable offer: the price may be fair, but the books aren’t ready for it. Timing your offer to after the write-down is often the difference between a deal and no deal.
When a banker turns down a fair offer, the price usually isn’t the problem; the books are. Ask how the asset is carried, and come back when your number and theirs can meet.
Check yourself: Why might a bank accept a lower price next quarter than it would today?
Lesson 4. When Banks Sell: Three Windows
| Stage | What is sold | Buyer gets | Typical discount |
|---|---|---|---|
| Before foreclosure | The note and mortgage (a note sale) | The lender’s rights; must still resolve the loan | Deepest: time, legal cost and outcome risk |
| At the foreclosure sale | The property, at the clerk’s auction | Title subject to the sale process; little inspection | Moderate; cash and speed required |
| After foreclosure (REO) | The property, sold by the bank | Title and possession; can inspect and finance | Smallest; bank has already absorbed the loss |
Before foreclosure a bank cannot sell the building; it can only sell the loan. A note sale transfers the lender’s rights, and the buyer then chooses the resolution: a discounted payoff, a loan modification, a deed in lieu, or foreclosure. After foreclosure, the property becomes real estate owned (REO), and the bank sells it like any owner, though usually with an eye on carrying cost and timing.
Lesson 5. Florida Foreclosure
- Judicial process. Florida lenders foreclose through the courts: file suit, record a lis pendens, obtain a final judgment, then a sale by the county clerk, most of them online.
- Right of redemption. The borrower can pay the judgment amount and keep the property until the clerk files the certificate of sale.
- Time is the cost. Contested commercial foreclosures can take a year or more; every month adds legal fees, taxes, insurance and the risk that the property deteriorates. Note buyers price that time directly.
- Check other liens. Property taxes, tax certificates and code-enforcement liens can survive or complicate a foreclosure; title work comes before price.
Lesson 6. Pricing a Non-Performing Note
Price a note the way the market does: list how the loan is likely to resolve, the cash and timing of each outcome, and its probability, then discount at your required return. For our loan, at an 18% annual target:
| Path | Probability | Cash flows | Present value |
|---|---|---|---|
| A. Discounted payoff | 35% | $15,000 legal in month 1; $1,500,000 payoff in month 6 | $1,366,067 |
| B. Foreclose and sell REO | 65% | $45,000 legal in month 7; title in month 14; $5,000/month carry to month 20; sale nets $1,426,000 after 8% costs | $1,017,790 |
| Probability-weighted bid | $1,139,687 |
That bid is 57¢ on the dollar of the $2,000,000 principal balance, or 73.5% of the property’s as-is value. If the borrower pays off at month 6, the buyer clears about $345,313 before overhead; if it goes to foreclosure, about $211,313 over 20 months. The 18% return compensates for the time, legal risk and uncertainty.
Now compare it with Lesson 3. The bank carries the loan at $1,395,000; a $1,139,687 bid would cost it another $255,313. Unless the bank is ready to take that loss, this bid will not trade today. The buyer’s choices are to wait for a further write-down, accept a lower return, or find a resolution worth more (for example, a borrower ready to pay off sooner). Change the assumptions yourself:
Apply it on a real deal
- Before bidding on a note, get the loan file basics: balance, rate, maturity, guarantors, payment history, and the most recent appraisal or BPO.
- Write down every realistic resolution path with timing, costs and a probability; make the probabilities add to 100%.
- Discount at the return you require for this risk, and compare the result with the bank’s likely carrying value (as-is value less costs to sell).
- If your price is below the carrying value, ask when the bank expects its next review, and stay in touch instead of walking away.
Lesson 7. Buying REO From a Bank
Once a bank owns the property, the loss is already on its books and its priorities change: stop the carrying costs, avoid surprises, and close cleanly. Price REO like any acquisition (Course 1’s NOI, cap rate and DCF), then add a distress discount for condition, vacancy, deferred maintenance and the bank’s limited disclosures; REO is usually sold as-is. Because the bank has already absorbed the write-down, REO sells closer to market value than notes do, and buyers who close quickly with certainty are often favored over higher offers with conditions.
Lesson 8. Working With Banks
- Find the right desk. Problem loans and OREO sit with special assets or OREO officers, not the loan officer who made the loan.
- Lead with certainty. Proof of funds, a short due-diligence period and a clear closing date matter more to a bank than an extra few points of price.
- Respect the record. Banks answer to examiners. A buyer who supplies a clean, documented basis for value (a BPO, comparable sales, an underwriting summary) makes the bank’s decision easier to defend.
- Be patient. Timing follows the bank’s reviews and write-downs. Many of the best deals come from relationships kept up over several quarters.
Linton Global Solutions works this side of the market every day through its Bank Owned Solutions and BPO services.
Capstone: Price a Distressed Loan
Choose a distressed commercial property in a county on the Market Map, real or hypothetical, and write one page:
- The loan. Balance, rate, status and grade (estimate it from the facts).
- The collateral. As-is value from comparable sales and the Market Map’s commercial $/SF; note condition and occupancy.
- The bank. Its likely carrying value (as-is value less costs to sell) and how much it has probably written down.
- The paths. At least two resolution paths with timing, costs and probabilities.
- The price. Your bid at your required return, in dollars and cents on the dollar.
- The gap. Your bid against the bank’s carrying value, and your plan: bid now, wait for a write-down, or pursue a faster resolution.
Key Takeaways
- ✓Distressed prices are set by the lender’s position, not only the property.
- ✓Regulatory grades (special mention, substandard, doubtful, loss) show how much pressure a bank is under.
- ✓Carrying value is the key number: a bid below it forces a new loss. In our example, $1,395,000 vs a $1,139,687 bid.
- ✓Banks sell notes before foreclosure and property (REO) after; discounts shrink as the bank absorbs the loss.
- ✓Price a note by probability-weighting its resolution paths at your required return: 57¢ on the dollar here.
- ✓In Florida, judicial foreclosure and the right of redemption make time the biggest cost.
Frequently Asked Questions
What is a non-performing loan (NPL)?+
A loan on which the borrower has stopped paying as agreed, usually 90 days or more past due or placed on nonaccrual by the lender. Banks can work the loan out, foreclose, or sell the note to an investor, who then holds the lender’s rights against the borrower and the collateral.
How do you price a non-performing commercial note?+
Estimate how the loan is likely to resolve (a discounted payoff, a modification, a deed-in-lieu, or foreclosure and sale of the property), the cash and timing of each outcome, and its probability, then discount the expected cash flows at your required return. In our example, a $2,000,000 defaulted loan on a $1,550,000 property prices at about $1,139,687, or 57¢ on the dollar of principal, at an 18% target return.
Why won’t a bank sell a bad loan at a discount?+
Because a sale below the loan’s carrying value forces the bank to book an additional loss, which reduces capital. In our example the bank carries the loan at $1,395,000 after writing it down; a $1,139,687 bid would cost it another $255,313. Banks often sell after they have written a loan down far enough that the sale price covers the carrying value.
How does foreclosure work in Florida?+
Florida uses judicial foreclosure: the lender files a lawsuit, records a lis pendens and must obtain a final judgment before a sale. Sales are conducted by the county clerk, most of them online. The borrower can redeem the property by paying the judgment amount until the clerk files the certificate of sale. Contested commercial foreclosures can take a year or more.
What is the difference between buying a note and buying REO?+
Before foreclosure, a bank can only sell the loan (the note and mortgage), so the buyer steps into the lender’s shoes and must still resolve it. After the bank takes title, the property is real estate owned (REO) and the bank sells the building itself. Notes trade at deeper discounts because the buyer takes on time, legal cost and outcome risk.
Is this course free?+
Yes. Every lesson and calculator is free. The course is original material, is educational only, and is not affiliated with any designation or training program.
Sources: federal banking agencies’ uniform credit classification definitions and the Comptroller’s Handbook (occ.gov); FDIC call report data (fdic.gov); Florida Statutes Chapters 45 and 702 (judicial sales and foreclosure). Educational content only, not investment, legal or tax advice. The worked example is hypothetical. This course is original material from Linton Global Solutions and is not affiliated with, endorsed by or a substitute for any designation or training program.