Enter your e-mail address and password below.


Forgot your password? New User? Register Now.
   ARTICLE   |   From Scotsman Guide Commercial Edition   |   February 2013

Underwater Deals May Yield Treasure

Take a look below the surface of maturing loans to find bargains

Underwater Deals May Yield Treasure

Recent economic indicators, including the dip in the unemployment rate to below 8 percent, have kept hopes afloat in the past year with signs of potential stabilization, or perhaps recovery, in the overall U.S. economy. Looking ahead, however, some uncertainty remains over an estimated $2 trillion of commercial real estate debt that will mature by 2017. Many of these maturing loans do not have a clear exit strategy, given that, by some estimates, half of them will be underwater upon maturity.

These legacy loans will require some type of restructuring or discounting to bring leverage back in line with underlying asset values. Commercial mortgage brokers must be knowledgeable about the possibilities these loans offer when they interact with investors who think that attractive deals are drying up. If brokers and investors take a different perspective and see the bargains available in these underwater deals, then the next few years may be more fruitful than currently anticipated — for investors and commercial mortgage brokers alike.

In the coming years, commercial mortgage brokers must be more creative in deal sourcing than they may have been in the past. Going forward, brokers can expect many commercial real estate investment opportunities to come through historically nontraditional channels, including:

  • Note acquisitions that are either negotiated or through loan-sale advisers
  • Owners looking for outside equity injections to underwater properties
  • Purchases of bank real estate owned (REO) assets

Although all of these options can represent investment opportunities for clients — giving them the chance to place capital into value-added real estate projects — these options all have one common theme: deleveraging. The legacy lenders on these underwater loans often decide to remove problem loans from their balance sheets.

This deleveraging can happen in various ways, but the end result is hopefully a newly capitalized project with debt levels appropriate to today’s market.

Banks, commercial mortgage-backed securities (CMBS) special servicers, life insurance companies and other traditional debt providers will continue to sell, restructure and generally dispose of real estate assets and loans over the next several years at a measured pace.

Commercial mortgage brokers must realize that although stabilized and fully marketed real estate deals are a constant in their business, the opportunities hidden in these underwater properties may not always be there. To capitalize on this market, brokers must work with savvy investors and work with lending institutions acting as sellers. These lenders-turned-property- owners or distressed-note holders are looking to minimize losses on nonperforming or underperforming loans, and they often face regulatory pressure to remove the loans from their books.

There also will be opportunities for investors who want to invest in smaller deals in secondary and tertiary markets. Opportunities under $10 million in the Midwest and the southern states tend to face less competition from large institutional equity players and lenders. Investors willing to venture into some of these smaller markets often will find willing sellers. These markets also offer opportunities to deploy capital at greater returns than what can be accomplished in the coastal markets.

The lender as seller

It is critical to understand how to work with the lenders holding these underwater loans. They eventually will seek to remove the credit from their books and re-deploy the capital into new opportunities — perhaps outside of commercial real estate. They typically will seek to resolve these loans in one of three ways:

  1. Right-size the loan balance at maturity through a large equity injection by the borrower — if an extension is even entertained. Third-party investors often can come in and offer “rescue capital” for a partnered equity stake in the property.
  2. Foreclose on the loan and sell the underlying collateral. This often is done through a third-party broker, and often through online auction sites.
  3. Sell the loan at the maximum price attainable,oftentimes at a discount to the par value. Again, third-party brokers and auction websites are used to sell these loans in an accelerated fashion. Hard deposits are required — often at 10 percent of the loan-purchase price.

In each of the preceding scenarios, nimble and well-positioned buyers, with the assistance of savvy mortgage brokers, have the opportunity to take advantage of a motivated seller. The commercial real estate assets being sold in these scenarios often are not in a state of physical or economic distress, but rather “situational distress” — assets that are over-leveraged and being managed by a fatigued lender with little real estate management experience.

In these instances, the lender, as a seller, is looking to limit its loss, capture the highest amount of proceeds possible, and accomplish both of these in the shortest time period. To take advantage of these fast-moving opportunities, buyers must be able to close without financing contingencies or with a dependable bridge-lender partner.

Distressed-loan outcomes

Commercial mortgage brokers should consider all the possible outcomes of a distressed-loan scenario. For example, consider the case of a commercial real estate developer that financed a retail project in 2005. The property now is worth less than the face value of the debt owed on the asset. Tenants have left the property, rents have fallen from peak pricing, and although new tenants are seeking to lease the space at lower rental rates, there is a need for capital to pay for tenant improvements and leasing commissions. To add to the complexity of the situation, the existing lender has called a maturity default and is not willing to offer any extension or forbearance options. Because this loan may be nonrecourse and is not covering debt-service payments, there is little incentive for the borrower to make interest payments out of pocket or inject a large amount of new capital into the project to right-size the loan and find a new conventional lender.
In the preceding scenario, there are several potential outcomes for the asset, each with its own pitfalls with conventional financing.

  1. The original lender forecloses on the asset and sells to a new owner. A new operator sees this as a value investment, but few lenders are willing to lend on an underperforming asset that is being operated by a bank or receiver. The asset will be deemed unable to cover debt service upon the inception of a new loan, and thus only all-cash buyers can purchase the now distressed asset. Constraining the buying pool to this group reduces asset pricing and therefore the bank’s ultimate recovery.
  2. The bank offers the borrower a discounted payoff on an existing loan. In this situation, it is difficult for a borrower to find a new lender to provide the capital to pay off the legacy lender, both because the payoff opportunity is likely only available for a short period of time and because there is institutional reluctance among banks and traditional lenders to replace what is viewed as a competitor’s problem.
  3. The bank sells the loan at a discount. Lenders may take this approach to achieve a quicker resolution than they may get through foreclosure and sale, to potentially preserve a banking relationship with a customer, or simply to get the bad loan off the balance sheet quickly. Commercial mortgage brokers should understand that smart investors must step in quickly and invest capital at a conservative valuation, with either a loan payoff or eventual fee simple ownership as the ultimate value opportunities.

Get deals closed

When working with investors trying to capitalize on these opportunistic deals, commercial mortgage brokers must keep the following four lessons in mind to ensure that their loans close smoothly and on time:

  1. Don’t assume. There is a danger in assuming that banks will lend on fast moving and opportunistic investments. It is equally wrong to assume that there are no capital providers looking to invest in opportunistic situations. Do your homework and evaluate all options.
  2. Understand the investor’s position and desired outcomes. Is your client a property owner? If yes, does your client want to retain the asset and create value? Remember, a client may be feeling stuck in a no-win situation with the current debt structure. Finding an equity partner or a bridge lender to recapitalize the investment may allow your client to continue owning and managing the asset, oftentimes at a reduced debt level.
  3. Time is of the essence. Know your client’s time horizons. If traditional lending sources are unlikely to be an option to restructure your client’s debt on an existing asset or to acquire a new property, it’s better to acknowledge this and let your client know as early as possible so that you both can start making alternative plans.
  4. Deal with trusted partners. The dynamic financing markets, coupled with the great need for capital and the promises of new and lucrative opportunities, have given rise to new names and players promising solutions that they cannot deliver. Do your homework, get references, and make sure you are dealing with capitalized partners that have a verifiable track record of honest and responsive business practices.

• • • 

The rising tide of an improving economy may raise all ships, but many boats will continue to be tied down with legacy debt issues. Dealing with underwater properties often provides unique and fast-moving opportunities for mortgage professionals and investors alike. Commercial mortgage brokers working with investors who are willing to take the plunge and invest — with the help of private debt-and-equity providers — in these opportunities may find successful deals with superior returns.

Bubble 0 Comments

By submitting this comment, you agree to comply with our Terms of Use.

The text exceeds the maximum number of characters allowed.

Are you sure you want to permanently delete this blog comment? This action cannot be reversed.

You must enable your community profile to use this feature.

Cancel Enable profile

You have flagged this post for inappropriate content.

Please explain below. Thank you.

Cancel Submit

Fins A Lender Post a Loan
Residential Find a Lender Commercial Find a Lender
Scotsman Guide Digital Magazine

Related Articles



© 2017 Scotsman Guide Media. All Rights Reserved.  Terms of Use  |  Privacy Policy