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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   July 2016

The New Face of Distressed Property

Defaults are still a threat for commercial borrowers, even for those who have recovered from the meltdown

The New Face of Distressed Property

The economic recovery has created some breathing room for commercial real estate owners who fought off foreclosure during the recession. The better times, however, mask a new set of financing woes for those attempting to refinance loans underpinning commercial mortgage-backed securities (CMBS).

After recovering from the shock of the 2008 economic collapse, the CMBS market is bracing for another period of trouble. The causes and effects of this financing tumult are different from what they were in 2008, but for some investors they are no less severe.

While the wave of economically driven distressed commercial properties hit hard and lasted a long time in the wake of the last recession, the landscape has changed a lot since 2008. The troubled-asset count has dwindled since then. Although opportunities still exist to buy distressed commercial real estate at a discount, the options are not as plentiful as they were five years ago. The next chapter in the CMBS story will involve a new borrower, one who has survived the economic downturn, as well as a new type of investor.

Difficult negotiations

When a distressed property lands in a special servicer’s portfolio, many borrowers think they will be able simply call the asset manager and explain the problem, which will result in a modification that will make sense.

That is the first hurdle a borrower must overcome. A distressed property is someone else’s opportunity, and if the special servicers think that the owner can no longer operate it successfully, they will step in on behalf of the trust. This creates a chain of events that starts with foreclosure and ends with the sale of the borrower’s property to the next investor.

Your distressed property is someone else’s opportunity, and if the special servicers
believe that you can no longer operate it successfully
they will step in on behalf of the trust.

Sometimes, circumstances beyond the control of property owners, like an anchor tenant declaring bankruptcy nationally, can put a property into a tailspin that cannot be reversed. The borrower is deemed a bad operator, and the property hits the auction block.

There are other instances where a borrower ends up in special servicing due to a default. Even while they feel like the special servicer is negotiating with them, they suddenly find that someone else has bought the promissory note that is secured by the property, and that new investor plans on foreclosing to take possession.

Glut of maturities

The unprecedented number of commercial mortgage defaults during the economic collapse allowed investors to obtain properties at prices that, in many cases, created a substantial financial upside. In the years since, the market has stabilized and the number of distressed properties has declined, but we are still seeing the effects of the collapse in the performance of today’s credit markets.

In 2006, investment groups were buying up securitizations with large asset portfolios and large amounts of debt. Between 2006 and the crash in 2008, a substantial number of CMBS loans were originated and secured by an even larger number of properties. Most were 360-month amortizations with 10-year maturity terms. The result is an enormous number of CMBS loans coming due this year.

If borrowers are reaching maturity on one of those CMBS loans, they naturally want to line up a new lender. One problem is finding someone that lends in that space.

CMBS lending has stalled this year. At the same time, the broker who originated the borrowers’ mortgage — possibly their one contact for a new CMBS loan — may have fallen victim to the market’s crash and no longer works with the lender that originated the loan. In some cases, the originating company also might have been shut down and no longer exists because of the collapse.

So, even though the borrowers have a performing loan on the property, are covering debt service and see an opportunity for a little upside in the future, they face the very real prospect of receiving a note of default from a special servicer when their CMBS loan comes to maturity.

New borrowing options

There are plenty of options to remedy the current CMBS problems, if you know the right people. There are borrower advocates who know how to restructure loans, but they do not always have access to good lending. The key, as a broker, if you want to be successful in helping to negotiate clients out of a maturity default, is to assure you have solid relationships with a slate of lenders that can perform in that area, or you need to begin building that network.

Online auctions have become one of the main vehicles for the disposition of distressed commercial real estate over the course of the last six years.

In 2008, there was no platform to sell the promissory notes or real estate owned (REO) assets online. In fact, many of the documents needed to complete a sale did not exist in digital form. The creation of online-auction platforms has changed that. Online auctions have become one of the main vehicles for the disposition of distressed commercial real estate over the course of the past six years. Investors have access to properties now that they may not have known about previously.

In addition, there are more small lenders now active in the market, and they are offering new lending products. They have the ability to lend with a higher loan-to-value ratio than traditional CMBS lenders. This is very important if the value of your clients’ property has been driven down by the loss of tenants.

Finally, some lenders look at properties on a case-by-case basis and will build into the new financing much-needed tenant-improvement costs. This not only gives you the loan your clients need to avoid a default, but also provides them with the ability to upgrade, lease up and stabilize their property.

• • •

A wave of borrowers who cannot find lenders to refinance their CMBS loans now face the prospect of being thrust into negotiations with servicers, a situation that could result in a wave of foreclosure actions. This down cycle in the commercial-property market won’t emphasize occupancy rates, and it won’t be about loan modifications. It will be about extensions and new lending.

The glut of CMBS borrowers whose loans are coming due over the next two years will face challenging and sometimes unexpectedly rigid finance markets. Negotiations with special servicers can quickly turn into default proceedings, and borrowers unable to secure loan modifications will, instead, be fortunate to obtain extensions or new loans. This will be a season of maturity defaults, and they will become the new face of distressed commercial real estate. 


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