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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   May 2012

Climbing Out of Distress

Take advantage of the market’s opportunities by matching distressed properties with the right lender

Climbing Out of Distress

Many loans that were made at the height of the market are coming to maturity this year and for the next few years — and many of these properties are already underwater. In 2012 alone, Trepp LLC anticipates $69.9 billion in commercial mortgage-backed securities to mature. Savvy commercial mortgage brokers may spot a growing demand in the market for refinancing or note purchases — either because the property has been foreclosed or because the loan is maturing and has to be rolled over. Bridge loans may provide the right financing for many of these deals.

A thorough understanding of the ins and outs of the bridge-lending process, how to select the right lender and how to determine asset value is crucial to your ability to provide your clients with help and guidance for these deals.

To start, commercial mortgage brokers should be aware which lenders are willing to take out existing debt. These deals may require a bridge lender — as opposed to a hard-money lender — because many of these properties likely still generate cash flow, just not at a level that is sufficient to service existing debt. Lenders typically will buy that debt or notes at a discount, however. 

"Many loans must be bought out because banks don’t want to be in the business of owning real estate and are looking to divest these assets, even at a significant discount."

Potential borrowers will need your help to find a lender with the right experience in this area — particularly if they are under time pressure. In many cases of a discounted payoff or a note purchase, a borrower has to negotiate with a new lender while also negotiating with the old lender. This can turn into a catch-22 if your client strikes a deal with the old lender before reaching an agreement with the new lender. The old lender typically will want to make sure there is a new lender in place before proceeding with the deal. That’s where experience in dealing with these situations can help speed the process.

For example, if your client needs $10 million in 30 days for an opportunity to buy out an existing note at 50 cents on the dollar, but the client doesn’t actually have a contract in place with the previous lender because the latter wants to make sure the client has the money in place, you must work through that.

That’s a typical example of what commercial mortgage brokers may encounter in note purchases today — there’s a lot of activity in discounted payoffs. In addition, many loans must be bought out because banks don’t want to be in the business of owning real estate and are looking to divest these assets, even at a significant discount.

Look for opportunity

Many investors are looking to take advantage of the discounts available in today’s distressed markets, and mortgage brokers must be aware of the individual circumstances of each deal. Whether it is a note or a distressed property with debt on it, it could be underwater for cash-flow reasons. There also could be equity partners involved in the transaction. For example, a group of equity partners may take an opportunity to buy a vacant warehouse that was not generating any income from a bank that had foreclosed on the property. The bank is willing to sell the property at an advantageous price, and the partners are interested in converting the warehouse into a data center.

There are numerous similar opportunities for entrepreneurs to buy distressed properties and convert them into a business that can generate cash flow. In the preceding example, the warehouse is a perfect space for a data center — and data centers represent a real estate sector that is growing rapidly.

As for other sectors to watch, apartments have done well, hotels have seen a resurgence and office-space transactions always exist regardless of the status of the market. 

Many are taking note of these market opportunities. Based on year-end 2011 data for sales in office, industrial, retail and multifamily, distressed property sales totaled $21 billion this past year, up from $20.6 billion in 2010, according to CoStar Group data. The research company projected a continued elevation in distressed transaction activity this year. 

Find the right lender

With these points in mind, commercial mortgage brokers can proceed to the next step: finding the right lender. The ability of the commercial mortgage broker to match the deal with the right lender is crucial, and there are a couple points that must be kept in mind to make the correct choice.

First, note the size of the deal and the borrower’s quality — both are important factors in a lender’s decision. Remember, a lot of capital is chasing larger deals because it takes as much work to do a $5 million deal as it does to close a $50 million deal. That is why you may find a lot of the so-called “deep pockets” unresponsive to smaller loans. 

Second, some brokers may be tempted to contact every lender in their database and hope two or three of them will issue term sheets — and one will actually get a deal done. The more sensible approach is to focus clearly on the needs of the lender and only reach out to those particular lenders who specialize in that category. With the availability of information on the Internet today, it’s no secret who’s doing what — including the bridge lenders that are lending into certain spaces and the ones that aren’t. 

Determine value

For the deal to proceed, you must determine the true value of the asset and how much a lender likely is willing to provide. To start, you must remove the bias various parties may bring to the transaction. A borrower who previously owned a property will have a bias of value — just as a homeowner would. Go strictly with today’s market value. 

There are two ways of estimating how much to get from a lender:

  1. Loan-to-value: Typically based on an updated appraisal, which any lender will require; and
  2. Loan-to-cost: Typically based on what the individual is paying for the property.

Although a lender could lend at a percentage of either of those numbers, there are some that will lend on future value based on a construction loan or conversion project. For example, the current value of the building might be $10 million, but after a borrower invests $5 million more in the property, that figure is projected to double to $20 million. Lenders — depending upon their strategy — may do an initial loan and then do draws over time. This allows the borrower to access more money to complete the work required for the conversion.

Commercial mortgage brokers also may encounter borrowers who are looking for cash-out financing. For example, say a client built a new hotel, put $10 million of equity into it and had a $10 million note. If the client believes that the hotel is worth $20 million and wants to borrow $15 million to pay back the note and get $5 million back, that may be a tough sell. Lenders likely will want to make sure that borrowers have skin in the game so there is an incentive to pay loans back.

Be prepared

When it comes down to getting the loan done, the most important factor is to have your ducks in a row when the term sheet is signed. Make sure the borrower has all the required information and documents to avoid going back and forth between the borrower and the lender.

There’s nothing magic about this: It is your role as a commercial mortgage broker to know what the borrower must provide to a lender in terms of financials, historical information, environmental appraisals and so forth. The faster that information gets to the lender, the sooner the process of underwriting can start.

The other piece of the puzzle is to have the deal buttoned up as soon as possible to avoid unnecessary costs for your clients. In many cases, if a deal stalls, a borrower will be forced to pay an existing lender to get an extension until an agreement is worked out with the new lender.

For note purchases, brokers can look to conduits for consummating and negotiating these purchases with third parties and banks. The key is to look for a lender with adequate experience and resources — a lender that is willing to get involved directly with the old lender holding the note, for example. 

• • •

Clearly, there are deals to be had in distressed properties, but not everyone will succeed in this niche. Ultimately, it is incumbent upon commercial mortgage brokers to do their homework, learn from experience and match borrowers to lenders in a way that everyone involved in a transaction comes away happy. 


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