3 steps to winning a Commercial Loan Restructure
February 11, 2021
We are in the midst of the greatest pandemic seen in at least a century. The devastation to both the health and wealth of the US is extraordinary and perhaps unprecedented. Despite the horrific death toll and tragic consequences of the virus at the human level, we are arguably in a bit of an economic honeymoon of sorts. The Federal Reserve is pumping trillions of dollars into our economy, which is glossing over the true depth of this economic destruction. Stock markets and other asset classes are reaching all-time highs, not because the underlying fundamentals are solid; they aren’t. When trillions of new dollars are pumped into the marketplace, massive bubbles are inevitable. The evident problem is bubbles always pop and this time the bubbles will not only pop, but the bang will also be bigger.
For commercial real estate owners, investors and managers, the story is incredibly mixed. The value of your investments are either peaking or plummeting; the market bifurcation is arguably unprecedented. If you are one of the unfortunate few to be holding the wrong food group, i.e. hospitality, the near term looks fairly bleak and we would like to be of assistance, however, we can.
Generally, the lender/servicer granted Covid “Time-Outs” are expiring and yet the underlying fundamentals have not improved, at least not significantly. This time it is different and unfortunately, you were caught in a pandemic that triggered an economic crisis that simply was not your fault. It is critical that you understand your options and opportunities to survive, retain your ownership interests, avoid foreclosure and perhaps grow your portfolio with strategic acquisitions.
Demand destruction has been catastrophic with certain industries bearing the brunt: travel (airlines and cruise ships in particular), entertainment, hospitality, casinos, and retail to name a few.
The shape of the recovery is really difficult to determine and the variables are legion. The most important element for a sustainable recovery to take hold in earnest is our ability to ensure that people are safe while congregating. Essentially, we don’t want to put our lives, and the lives of those we care for, at risk by entering a public space. To this end, our current course of action across the globe is primarily dispensing vaccines. Projections based upon the current rollout of vaccinations indicate it may take up to 7.2 years for the entire world to reach herd immunity. The thing about a pandemic is that it’s not a local or even a national matter; until the entire world reaches some level of herd immunity all locations and populations remain at risk. As we accelerate deployment of our multipronged attacks, we will certainly accelerate the 7.2-year timeline, fortunately. Let me just say, as a sidebar, that we would be greatly benefited by ramping up testing (free, rapid, and abundant) and contact tracing. Knowing who is and is not infected is a game-changer. The other game-changer as it relates to CRE is Far UV lighting. For a primer visit www.faruvcco.com. This technology is going in everywhere. There is great hope and we simply need to get through these challenging times together, united.
The critical point of this article is: for commercial real estate investors, owners, and asset managers how do we manage our way through this indefinite period of time wherein our properties are deeply impaired. Of course, not all properties are impaired. If you are in the business of data centers. distribution locations or life-sciences, you are probably doing extremely well. Multifamily is also doing relatively well, depending on your location.
On the other hand, if you’re in the business of owning retail, hospitality, or office, well then you are experiencing a downturn, the likes of which we have rarely seen before in this country. Real estate is a local event and this has never been truer so, just as an asset class has a major effect on performance, location is critical.
One of the reasons that 90% of the nation’s millionaires earned much of their wealth in commercial real estate is due to leverage, which dramatically increases returns. Conversely, it is just that leverage that contributes to the equity and cash flow destruction during challenging economic times, at least in the short run. The natural solution is to work with your lender or servicer and create a mutually beneficial restructuring plan. The three keys in preparation for the restructuring are as follows:
1. Prepare a proforma:
Because the primary source of repayment of any debt comes in the form of cash flow, the preparation of a pro forma is going to be one of the most important documents you will prepare. Your pro forma has to be realistic, all assumptions need to be fully documented and supported, to the best of your ability. And all future cash flows have to be reasonable based upon market conditions, both now and in the future. You will be forced to make certain assumptions around forecasts regarding health and safety, which will be challenging. Be advised, if you are already in default, there is a decent chance that your bank counterpart has already prepared their version of your property’s economic future. This is done largely because it’s important that your lender solves for both cash flows and valuations as part of regulatory requirements. Fortunately, lenders and some servicers in today’s pandemic challenged world have been granted some leeway in marking some of their loan assets to market because. Suspension of some mark to market requirements is due, in some part, to needed relief and the belief that pandemic impairments are temporary. Bottom-line, if you do not have a comprehensive well documented proforma you are advised to create one and build both your knowledge and credibility. Proformas are a key component of the roadmap to recovery.
2. Prepare a well written, comprehensive proposal.
In the proposal, you are going to outline the steps, roadmap, taking you and your lender from today’s distressed situation to tomorrow’s recovery; this is critical, to say the least. In the proposal, you must clearly document the primary issues that are causing the reduction in cash flow. You must also identify any other issues tied to the real estate such as delinquent taxes, deferred maintenance, deferred capital improvements, etc.… Detail any issues associated with your gross stream and expenses. The more comprehensive your plan, the more credibility you will gain with your lender. The plan must take into account all business-related issues and walk the lender/servicer through how you are going to take the asset from its current state to one of performance. Remember, the lender wants to get repaid or at least not have to classify the loan as non-performing. Make it clear that your intimate knowledge of the real estate, tenancy, and market is critical to the turnaround of the property and that you are deeply vested.
3. Know your loan documents/pre-workout agreement (PWA), intimately.
If you do not understand your lender’s rights and remedies, then you are not in a position to have a comprehensive discussion, period. You need to understand the pitfalls associated with either action or inaction as a borrower. You will be asked, prior to entering negotiations in earnest, a pre-workout agreement. That agreement will ask you to stipulate to existing defaults and release your lender of all liability. Recognizing these are 2 significant deal points but, for the most part, that is the price to play. Also, while the PWA could go much farther in terms of requests, expect at a minimum, these basic components. Know all the potential pitfalls and traps and be prepared to address each default (monetary and non-monetary) as they will arise during discussions. Loan documents generally favor the lender which gives them the advantage. Minimize this advantage by becoming an expert.
The world of loan restructures and workouts can be incredibly complex. Knowing your lender is an important component of preparing for discussions. A commercial center bank will act and react entirely different league than a CMBS special servicer (who are notoriously difficult). A private lender or hedge fund will likely act and react far differently than a credit union or life company. The rationale behind the different approaches to a loan workout and restructure are complex, but suffice it to say, revolves around regulatory oversight and the guidance delivered to the front line special assets officers by the key stakeholders.
Communicate early and often and work towards a relationship of trust and mutual interests. It is also critical that you are open and transparent in your discussions. Associates in the Special Assets departments are often the best and brightest. Loan losses are greatly affected by the experience of the Special Assets Officer so they tend to be well trained, deeply experienced, and intensely focused on their roles. In certain situations, your ability to retain an asset or interest in an asset, whether as an investor or owner, is partially dependent upon your relationship with your lender/servicer. SAO’s hold great sway over the outcome so treat them with respect, honesty, and some degree of humility; after all, you are seeking their assistance.
The way to maximize the opportunity is not to attempt to solve your challenges alone. Unless you have deep experience in loan restructuring and distressed assets, gathering a team of experienced professionals will be a solid investment! Most commonly the team includes a deeply experienced workout professional, legal counsel, and your accountant. In addition, the advice of your asset manager and the property manager is also important to gain a comprehensive clear 360° picture of your current situation and your projected future.
For more information, either visit us at www.performanceadvisorygroup.com or schedule a free 30-minute consultation at Schedule Call
