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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   July 2016

Jump-Start Troubled Properties

Bridge loans rejuvenate deals and preserve equity

Jump-Start Troubled Properties

Borrowers who find accessing bank financing problematic — including many commercial real estate borrowers — can benefit from bridge loans. Although the loans can be expensive, they are often the most practical path to energizing distressed projects, and borrowers often find them less costly than taking on partners to fund their deals.

While commercial real estate has largely rebounded from the last recession, distressed properties continue to be a problem in many markets, for both economic and demographic reasons. The rebound hasn’t necessarily been across-the-board, and some submarkets continue to struggle. In addition, there have been indications of another downturn on the horizon in this cyclical business. Finally, the propensity for millennials and the companies that hire them to gravitate toward urban areas has resulted in a suburban landscape often dotted with vacant office buildings.

Through it all, conventional lenders have continued to demonstrate a “once bitten, twice shy” attitude when it comes to financing distressed properties. That has created an opportunity for innovative bridge lenders to step in and provide the funding necessary to get these properties functional, repurposed if necessary, and operating at full potential.

In reality, conventional lenders generally like multifamily, retail and office properties, but are turned off by any negatives associated with an asset. Banks put performance metrics into a computer and determine whether criteria such as debt-yield and loan-to-value (LTV) ratios are met. If they are not, the deals do not close.

Bridge lenders, with a willingness to take a look at the upside, fill the resulting gap. They realize that there may be a higher loan-to-value ratio initially, but they also recognize that with money available to improve the asset, the LTV will go down in time, and the borrower will be able to refinance ultimately.

Lingering problems

The recession, of course, had an impact that was difficult to overcome, at least initially. A problem that accompanied the downturn was that property owners, largely for financial reasons, had difficulty maintaining their properties properly. As a result, the market saw an increasing number of instances where investors were acquiring assets — ranging from multi-family, to office buildings, hotels and retail — that had become substandard because of deferred maintenance.

That was especially problematic for hotel owners whose properties no longer complied with the standards required by the hotel chains. At the same time, many hotel and multifamily properties had become over-leveraged. Needing financing to improve and upgrade their properties, hotel operators in particular began to approach lenders as a resource to improve the assets, if only to expedite cosmetic improvements.

Even when transactions make sense, the fact that they are speculative propositions can make them unattractive to traditional lenders.

Deferred maintenance was, and continues to be, a problem for retail properties as well. Investors have been acquiring rundown retail centers, many of which have suffered because of the closure of major retailers such as Circuit City and Linens ‘n’ Things. Often the loss of a major anchor tenant results in a distressed property. Continued struggles among retailers, such as the recently announced bankruptcy of Sports Authority, is another troubling indicator of how internet retailing continues to damage brick-and-mortar retail.

As is the case with other types of properties, investors are on the lookout for opportunities to upgrade these assets and find new tenants, or even wholly reposition the properties. In reality, most banks are reluctant to make loans that support such repositioning deals, because half-vacant properties may have been acquired for a fraction of the anticipated value of the repositioned property. In other words, in bankers’ eyes, the borrower does not have enough equity in the deal.

A bridge lender, on the other hand, will make that loan, providing the money for asset improvements, paying leasing commission and carrying the debt during the repositioning. Once new tenants are found, the property becomes more appealing to traditional lenders, and the bridge lender’s loan can be replaced by traditional bank financing.

Timely solutions

Time is money, as the saying goes, and one key advantage that bridge lenders can offer most commercial property sectors is the ability to close a loan quickly. Another advantage: Bridge lenders are more willing than conventional lenders to look beyond the present to the future value of a property. That perspective provides the basis for offering the short-term financing required to upgrade a property to the point that the loan can be taken out with a conduit lender or permanent financing.

As a result, bridge lenders will routinely assist borrowers with out-of-the-ordinary situational loans. If the borrower has a strong track record, the bridge lender will take the long view regarding value-add potential — to the point where the loan can be refinanced with a conduit (or commercial mortgage-backed securities loan) or by a portfolio lender. The traditional lender, in contrast, will tend to have a greater focus on current cash flow.

Even when transactions make sense, the fact that they are speculative propositions can make them unattractive to traditional lenders. Bridge lenders are often more likely to step in after taking into account the location, demographics and potential for growth of the geographic market in which potential deals are located.

Banks also are often not interested in providing financing until distressed properties are stabilized with occupancy in the mid-90 percent range. Bridge lenders are more apt to base decisions on property valuation and leasing prospects. They offer terms that represent a significant advantage to borrowers who need to close the loan quickly and, at the same time, are willing to pay a bit more for financing rather than find a partner and sacrifice a significant upside.

• • •

In general, property type, sponsorship and geography are all important factors regarding the availability of financing, whether it be from traditional or bridge lenders. Transactions in Manhattan, for instance, draw a great deal of interest from lenders. But beyond Manhattan, many lenders are regional in their approach, or have geographic constraints. Ultimately, this has been creating a greater number of opportunities for lenders with the flexibility to enter underserved markets. The bottom line in lending for distressed commercial real estate properties is that bridge lenders are able to provide borrowers that are unable to obtain loans from traditional sources with the opportunity to obtain financing and jump-start their properties. Especially in the aftermath of any downturn in the highly cyclical real estate market, conventional financing is too often not available to investors that are buying underperforming assets. Savvy buyers and investors, however, need funding if their projects are to be successful, and the bridge lender remains a likely vehicle to make that happen.

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