In some parts of the country, a recovering local economy means the special asset (or problem loan) groups are reducing staff, as loan production groups come back to life.  Leaving the special asset group under-staffed could be a mistake if the staff is not able to properly complete basic foreclosure tasks.  One basic task is inspecting the property prior to taking title to the property (whether through foreclosure or a deed in lieu of foreclosure [FAQ series for information on deeds in lieu]).  Here’s a decision tree that might help you in deciding if an inspection “really” is needed, and a recent example that should energize you to look before you leap (into ownership of the collateral).   Decision tree: verify that your mortgage loan documents give you the right to enter the property, then

  • Current Inspection Report: ask yourself this question: “when was the last time that someone looked at every part of the property?” If the answer is “more than a few months” then a current inspection should be a priority
  • Court Ordered Entry: if the borrower does not allow you to inspect the property, then investigate (with your lawyer) the available court orders that could give you access to the property (in order to inspect it)
  • Extraordinary Situations:  of course, there are situations where inspecting the property just is not possible, with the result that –
    • Foreclosure is the only option (for example, the lien itself is about to lapse or expire) (I’m having a tough time thinking of other justifications to not inspect)
    • Receivership is the better option (for example, you already know of problems and your presence on the property [during an inspection] could cause you problems)

Still not convinced that an inspection should be a top-shelf priority item? Once Upon a Time . . . The phone rings and you’re called to meet with City officials at the police precinct office near your “new” apartment project (shortly after you foreclosed on what seemed like just another project). At the meeting, you’re introduced to the Chief of Police and representatives from the Mayor’s office, the zoning department, the City health department and a lawyer from the local District Attorney’s office.   They vaporize you with a list of alarming health and safety issues at the apartments. The bottom-line message was simple: you have 30 days to show some “progress” on the issues or the City would take enforcement actions. Their list included the following:

  • an active farm growing illegal plants
  • sewage flowing into one of the units
  • on unit has a 50 foot hole in it, with dirt piled up to the window
  • organized dog fighting

As always, it is the basic stuff that jumps up to bite you.  (And gets the immediate attention of your insurance group.) Please share your comments below.  

Most commercial real estate loan documents give meaning to the phrase “real estate is old as dirt.”  Why? Because just as dirt doesn’t change, commercial mortgage loan documents largely ignore the impact of technology on the physical attributes, use and operations of the property.   Take another look at your mortgage loan forms with these questions in mind, and ask yourself if the forms are “as old as dirt.” My bet is that you won’t like the answers to the question.  (Yes, it’s even embarrassing.) Do your mortgage loan documents cover:

  • third party (or “cloud”) documents storage?
  • require lender consent to any use of electronic (eSign) documents with tenants and vendors?
  • address use or surrender of internet or social media tools (such as websites, Facebook, etc.) upon a loan default?
  • turnover of hardware and data used in the operation of the property?
  • due diligence (check list items) on technology contracts used in the operations, marketing or leasing of the property?
  • continuation of these contracts following foreclosure (or deed in lieu)?
  • what kind of new defaults and remedies are needed?
  • annual listing of technology contracts and third-party services?
  • using e-mail as a permitted method of giving “notice?”
  • require a borrower to cooperate if and when lender implements new technology tools (such as online reporting)?

Of course, this is not an exhaustive list.  My list seems to grow every few weeks. I recently spoke on this topic at the Texas Bar Advanced Real Estate Drafting Course, and later this summer, I plan to do a webinar series on this topic. If you have questions to “add,” please comment on them below.

Acceptance by commercial real estate lenders of a partial payment in full satisfaction of the loan (as a “discounted payoff” – a “DPO”), prior to the maturity of the loan, is a topic that receives little “public” attention.

Here are a few reasons why we hear so little about this topic, and the challenges in actually paying off a commercial real estate loan at a discount (prior to maturity):

  • Confidentiality: many payoff agreements require the borrower and the purchaser (if different from the borrower) to NOT disclose the payoff
  • Segmented lender market: not all lenders are alike (life company; CMBS servicer; bank; mortgage REIT; etc.), and each type of lender has different regulatory constraints.  So, there is no “one size fits all.”  And, even within each lender type, each lender has its own balance sheet, loan allocation and credit policy limitations
  • Debt stack: the existence of multiple debt layers, and a debt holder who might not be “happy” with the payoff amount offered to it.  Complicated debt structures make a discounted payoff very, very difficult.  Indeed, combine this point with the second point (the “wrong” lender), and  . . .  difficult can be impossible

A DPO could be a sound business decision for a lender.  For example:

  • Accepting less than full payment on the loan could be a better economic decision than incurring the costs in exercising remedies, and then owning, reviewing and managing property (often called real estate owned or “REO”)
  • The  loss incurred by the lender (by being paid less than the full loan amount under the DPO) is less than “loss” of capital caused by the loss reserve for a bad loan on its books (bad loans are also referred to as “impaired” loans).  Impaired loans trigger increases in a capital reserves, which for some types of lenders (such as life insurance companies and the “mortgage experience adjustment factor” [or MEAF]) is an amount well in excess of the loan amount
  • Impaired loans generate intensive management reviews (another cost)
  • A DPO can close quickly and efficiently, typically much quicker than a deed in lieu of foreclosure
  • If lender is in sound financial conditions, and already has recognized the loan loss, the quick loss inherent in the DPO is a non-event

In a future post, I’ll cover some of the details in a DPO.

If you have other thoughts or experiences in this, please comment below.

 

2012 should be the year when online sales broadly impacts "how" retailers view and use their "physical" stores.  This will impact both the owners AND the lenders.

Record online sales point to the need (RIGHT NOW) to take a different approach in reviewing and approving retail leases – which for lenders with shopping center and mall collateral, brings new challenges in underwriting leases at loan origination and during the life of the loan.  And also, in assessing the time period that it will take to lease empty retail space – both during the life of the loan AND after the lender owns the property (after foreclosure or deed in lieu).

Retail collateral, if not already at the bottom of the food chain, is nesting in a very rough spot.

Here are the early statistics of interest for this holiday season –

  • 14% to 26% growth in online sales for various days & periods during the holiday season (over 2010) (reported by comScore on Dec 20)
  • 10 days showed online sales exceeding $1Bill each day (reported by comScore on Dec. 20)
  • 36% growth in individual online transactions (over 2010) (Investors.com)
  • 16% increase in online sales on Christmas day (ABC reports on IBM study)

And one comment, just to make it personal:

  • Human Vultures: Amazon has a "price check" app for your smartphone and tablet, which allows you to scan the bar code of a product (while you’re "in" a physical store) so that you can determine if the price for the product is cheaper on Amazon.  The app turns each of us into vultures – allowing us to pick over the physical store inventory, purchase only the store’s "loss leader" (that landed us in the store); but for any other product at "regular" pricing, we’ll fly away and buy from Amazon.  In a tough economy, we are very price focused. We are the enemy of sticks and bricks stores.

Technology changes everything, and retailing now is in the high beam.

 

This disruptive change in retailing should result in these changes for lenders and loan servicers:

  • Underwriting: this adds an entirely new, and complex, factor for underwriting decisions, such as –
    • what is the retail tenant’s online strategy? What is the online strategy of its competitors?
    • do the sales figures include online sales or deliveries (purchased online but picked up at the store)?
    • to what extent should you consider future online sales or deliveries – merely going to the "health" of the tenant or also going to the rental to be paid under the lease?  Could any of this change?
    • how will this impact or influence small shop owners? Will they need to compete online? Will a web presence be required for underwriting a small shop tenant?
  • Reviewing leases (during servicing & at loan origination): new lease clauses come into play.  For example –
    • does the percentage rent clauses carveout (or exclude) deliveries of goods purchased online but picked up at the store? What about purchases made at a terminal in the store?  Or on a smartphone in the store?
    • what is the retailer’s business model for the store?
    • will the retailer need LESS space at renewal?
  • Loan Documents: how will this play out in loan document provisions describing the lease and the approval process (for new leases and lease amendments)?
  • Dispositions:  how will this impact the disposition or sale of debt secured by retail space, or by foreclosed property that contains retail space?
  • Retail California? Will retail space be viewed, to some extent, like a hotel (as an operating company?)  Will "checking out" of the loan and collateral be a challenge?

Sure, all these issues will be resolved over time; but until then, it will be tough times.

If you have comments or suggestions, please post them below.

In the movie The Graduate (1967), Ben learns that one word  (“plastics”) is the pathway for a successful career.

Today, for distressed investments or for quality apartments (including apartments pointed to students as tenants), the pathway to higher rents, occupancy and value is this one word –

Technology.

The technology attributes of a community can be a latent impediment to the health of the project:

  • cell phone coverage (dead spots where calls are difficult to make or to receive)
  • proper cable for internet and TV connections
  • convenient and stable places to attach satellite TV dishes
  • wifi in common areas [such as the pool and lounge areas
  • quality service providers for internet and TV

Proud of the pool and common areas?

That is so . . . yesterday.

Looking for a quick solution to rental rates and low occupancy?

The technology available for use in an apartment community is no longer an amenity. It is a basic service – no different from electricity and plumbing.

So, before you consider funding another dollar on the apartment community, or before you approve the workout terms (as you modify the loan), or before you take the property back (via foreclosure or deed in lieu), consider doing some combination of the following:

  • Market Information
    • survey the current tenants on the importance of this topic
    • investigate competing properties on their services (and on complaints or compliments)
    • read tenant feedback on local blogs
    • understand the available services
  • Inspect the Property
    •  inspect the property for “dead spots” for cell phone usage (remember: NO ONE uses a “land” line)
    • test internet connection speeds (can you "stream" a movie on it?)
    • how are satellite dishes connected?
    • examine the type of cabling used in the property, and the location of connections in the units
    •  investigate the ability to furnish wifi coverage in the common areas
  • Legal Review & Plan: get an experienced lawyer to review the service provider contracts, and craft a strategy to
    • have the borrower renegotiate contracts on these topics prior to renewal
    • will a service provider pay all or some of the costs?
    • terminate these contracts upon foreclosure; and immediately after foreclosure address these basic topics as a quick way to improve the value of the project

This is such an easy way to reposition a property.

Poor cell phone reception, slow internet connection speeds and the wrong TV service provider is the silent assassin – it will drive tenants away and quietly limit the income potential of the community.

The tenant community is well aware of the importance of one word:

Technology.

If you have questions, comments or war stories, please post them below.

 

 

My prior posting briefly describes two typical tenant in common structures ("TIC"), and then addresses some of the issues effecting a workout where the borrower is a TIC.  (In a workout, "TIC" rhymes with ______.)

Here are two other major topics that come into play:

  • Documents: How do the loan documents,  the TIC documents and possible new documents address the following topics –
    • do the documents properly address the 15-part test articulated in Revenue Procedure 2002-22 (thus allowing the TIC investment to be classified as an investment in real estate, and not as an investment in a partnership)?
    • does the TIC structure comply with federal and state securities laws?  (Does the documentation and records of the TIC sponsor support the view that the TIC interests are a security?  The Sunwest senior living law suit shows that the SEC will actively pursue TIC sponsors in the proper case.)
    • do the notice provisions require actual delivery of written notices, or is delivery deemed given when sent? (This topic is huge: actual, physical deliver of notices to a large of TICs can be difficult.)
    • how do the documents address removal of the manager of the TIC or of the master lessee?  (See my prior posting for a depiction of the two typical TIC structures.)
    • how difficult will it be to engage a new manager? (Beware of the scope of the indemnifications required by this new manager.)
    • are the TICs willing to "roll up" the TIC structure into a single entity (such as a limited liability company)?
  • Tax Picture: What is the tax situation of each TIC?
    • Typically, each TIC has a low basis due to the 1031 Exchange (Consequently, a forced sale of the collateral, a deed in lieu of foreclosure or forgiveness of debt may create "phantom" income to the TIC investor, which results in a taxable gain for federal income tax purposes.)
    • This tax issue could be the motivating factor for a TIC in a workout or restructure

These fundamental topics will control a workout or restructure of any commercial real estate loan where the borrower is a TIC.*

If you have questions or comments on these topics, please post them below.

* While I have given presentations on this topic, special thanks to these Winstead lawyers, who gave me additional information prepared by them: Eli ColumbusErick Weiting HsuJeff MatthewsEd Peterson & Brian Short.

The check list is long for a lender or servicer as it takes title (via foreclosure or deed in lieu of foreclosure) to commercial real estate collateral.  And the situation some times can be . . .  challenging.

If the loan collateral is income producing property (hotel, industrial, apartments, retail, office building, etc,), then a primary focus is the tenants and their leases.

Also, Tenants may be claiming that the landlord (the former borrower) has not performed under the lease (for example, failure to maintain the property); and often, one or more tenants may be in default under the terms of their respective leases.

Dealing with a defaulted tenant is difficult.  Just as working with a distressed loan takes a different skill set and involves different issues than those used in originating a loan, dealing with leasing and property management issues requires an entirely new skill set when compared to dealing with a distressed loan.

But one thing remains the same: the value of the property is "in" the leases.  So, a primary focus is resolving (or dealing with) defaulted tenants and their leases.  Here are a few quick tips as you deal with defaulted tenants:

  • Experience; Lock Out: Staff should be experienced in handling tenant defaults in commercial property; for example –
    • locking a tenant "out" of the leased premises could be a basis for a tenant to claim that you have damaged the tenant’s business (possible solution: be reasonable and allow access to remove business records, personal property, etc.)
  • Remedies: Understand the landlord remedies –
    • in the lease,
    • available under local law
  • File Review: In order to understand the landlord remedies, organize and closely review the lease files, and any estoppel letters, subordination agreements or other written communication; and any action taken by you will be used by the defaulting tenant to its advantage; for example –
    • Does the lease require any surrender of the lease to be evidenced by the written agreement of landlord (to avoid acceptance of surrender of the lease = lease termination)?
    • Beware that making changes to even a portion of the leased premises could be a basis for the defaulting tenant to argue that it you have accepted the tenant’s surrender of the lease
  • Careful Communication: Communication with the defaulting tenant should be carefully crafted in order to avoid modifying the lease, waiving the default or giving the tenant a basis to assert a claim against you (as the new owner)
  • Understand: Understand the balance sheet of the defaulting tenant (in order to determine if it merits pursuing the tenant for future rent [if a permitted remedy under the lease or under local law]); but even it the tenant is solvent –
    • remember that attempt to recover or collect "future" rent could be a factual matter, and subject to different perspectives; which means that resolution (or determination) of the facts will be determined by a jury – so your success could depend upon "how friendly" juries typically are toward landlords who attempt to recover future rent
  • Mitigation: Determine if the lease or local law requires landlord to "mitigate damages" (such as to make reasonable efforts to re-lease the space)
  • F, F&E: Determine the landlord’s rights to the tenant’s fixtures, furniture, equipment and other property in the leased premises (and look for any agreements with tenant’s lenders, who could hold a security interests in such property)

If you have additions to this list, or suggested revisions to it, then please post a comment below.

 

Effective February 23, 2011 (next month), the new 2011 ALTA Survey Standards become effective (download a copy).  (Link to ALTA website and current 2005 requirements.)

What could this mean for you?  How is this relevant for distressed commercial real estate?

  • REO purchasers could require a survey prepared according to these standards (in part, because purchaser’s lender could require this); so, be aware of this possibility as you negotiate the REO sales contract
  • If you’re doing a deed in lieu of foreclosure, and you’re up-dating the existing survey, then consider doing the up-date with these standards – for the same reason set forth in the prior bullet point (i.e,, your buyer might require using the new standards)

I’m tying to locate a black-line of the new standards, so that we can quickly understand the changes (when compared to the current 2005 standards). **black-line found; see below***

If  you have comments about the new 2011 standards, then please comment below.

** Kudos to Ginger Simon (with Situs) for following up with me about the American Congress on Surveying & Mapping website, and giving me a link to the page  on the site that contains links to the black-line, a summary of changes and other helpful information.  Wow.  Thank you, Ginger!!

Enough of MERS and technology – but, how about technology but from a different angle?

The amount of commercial real estate debt in distress is huge:

  • delinquent unpaid balances on CMBS loans exceeding $62 billion (October 2010), and heading toward $70-$80 billion by year end ’10 (per Realpoint)
  • delinquency ratio of 8.04% (September, 2010) (per Realpoint)
  • Fitch predicts special servicing volume of @ $110 billion of CMBS loans by the end of 2010 
  • @ 3,000 banks and savings institutions have more than 300% of their risk based capital in commercial real estate loans (per JLL)

Late in the good economy, "green buildings" became a new distinctive for the newest construction.

This is the "technology-smart" building – designed, built and operated to be environmentally friendly for all of us, and resource efficient and healthier for the occupants.  And the rent is a little higher.  A good thing.  Unless the tenant moves out or goes bankrupt.

Combining the large number of distressed investments with the green building concept:

  • What does a "green building" mean for real estate lenders dealing with distressed debt? How much extra trouble is a green building?

A green building is an operational and legal disaster in the making for a foreclosing lender.

I brought this concern and my questions to Bill Weinberg, a friend and partner at my law firm.  As you’ll read in his answers to my questions, it depends on the nature of the collateral, where it is located, and what the lender intends to do with it.  But since Bill is the expert . . . . 

Keith: "first, Bill, thanks for that tip about adding this topic to my ‘watch list’ on distressed debt, and for alerting me on changes in local building codes that come into play on a construction loan – I actually blogged on it . . . over a year ago."

Bill Weinberg: "yeah, but you forgot to mention me in that blog . . . should I say ‘thanks?’"

Keith: "well the bet at the firm was that I wouldn’t still be blogging. . . so here’s your opportunity to see your name a bunch of times out there in the vastness of the internet . . . "

Bill Weinberg: "you need my help . . .  remember, your distressed debt decision tree list after ACMA did NOT even mention this topic"

Keith: "guilty . . .  bad oversight . . . this is a topic begging for trouble. . . Question #1: What is the first question, or step that needs to be taken?"

Bill Weinberg: "let me make this simple for you . . . and I know that you like bullet points –

  • What is the nature of the collateral?
  • Is it raw land, an occupied building, or something else like a half-finished building?
  • If the collateral is raw land, it is fairly safe to say that there is no green building issue. 
    • First of all, there is no building. 
    • Secondly, the lender will probably be long gone before anyone lifts a shovel to start work on a building.
    • BUT: you still need to get that environmental study BEFORE you take possession or take title 
  • If the collateral is improved . . . 
    • and an occupied building, the lender may have to maintain it appropriately
    • or is a half-fished building, the lender may have to build it appropriately
    • either way, you’ll still need to get that environmental study BEFORE you take possession or take title

Keith: " love how you talk in bullets . . . let’s just assume that you’ve taken possession or obtained title  . . . . foreclosure or a deed in lieu . . . . Question #2: what’s next on the list?

Bill Weinberg: "you’re the dog that just caught the car – so:

  • Do you know how to operate and maintain the green building features?
  • A green building may contain some high-tech features with which the typical maintenance or janitorial crew may not be familiar.
    • Do you know how to operate the solar panels or the rain water re-use system?
    • How about the geothermal heating and cooling system?
    • Does the janitorial staff know how to clean a waterless urinal?
  • Do you have the warranties for the specialized fixtures and equipment?
  • Don’t lose the value of the innovative features by neglecting to seek expert assistance.

If you have any comments, questions or war stories, please comment below.

More from Bill Weinberg shortly . . . .

Forbearance agreements are a staple of dealing with distressed investments.  They can be a stand alone agreement, or even combined with the terms of a negotiation agreement.

But before we focus on forbearance agreements, I have two sidebar comments:

Now, back to Forbearance Agreements . . . .

  1. What is a Forbearance Agreement?

It is an agreement by the Lender to forbear or refrain from exercising remedies for some specified period of time (usually the earlier of (i) a set date, (ii) a failure of the borrower to comply with the terms of the forbearance agreement or (iii) an additional default under the loan documents).

Typically the forbearance agreement does not extend the maturity of an accelerated or matured debt or waive defaults, but will obligate the Lender to forbear from exercising its rights against the collateral, the borrower and any guarantor during the forbearance period.

       2.  Why? What is the purpose of a Forbearance Agreement?

Some of the purposes could be:

  • Gives borrower time and opportunity to find an investor to pay down loan or to invest capital in the collateral, a take out lender or discounted refinance
  • Gives borrower and Lender with additional time to negotiate more permanent workout solution, (i.e., modification of the loan, deed in lieu, discounted payoff, etc.)
  • Gives borrower additional time to address issues with collateral which may enhance the possibility of other workout solutions (i.e., obtaining or replacing key tenant(s), making improvements or repairs to the property, eliminating code violations or other adverse conditions. . .)
  • Allows Lender to obtain a "clean slate" through releases, waivers, and acknowledgments of enforceability of loan documents, the amount due, existence of defaults and absence of any defenses, claims, or rights of offset
  • Allows Lender to "clean up" any deficiencies in the loan documents and to improve documents by adding provisions left out of the original loan documents (i.e., waivers of notices, jury waivers, forum selection clauses . . .)

Finally, as a practical matter, the need for a forbearance agreement pre-supposes that the lender has a near-term ability to exercise some right, or has taken some sort of remedial action – such as declaring a default or even starting the foreclosure process. 

In another posting, I’ll cover some of the typical terms of a Forbearance Agreement.

If you have comments or additions to any of this, please post a comment below.