When the commercial real estate crash struck, The Bascom Group found itself squarely in the path of a tornado of bad news with no safety net.
Irvine, Calif.-based Bascom’s business plan was simple: Acquire and reposition apartment properties using short-term loans. Unfortunately, as property values sank below their loan balances, borrowers like Bascom set about looking for ways to extend, renegotiate, or pay off these troubled loans—while avoiding the looming fear of foreclosure.
Bascom lucked out. Over the past three years, the firm has successfully extended, refinanced, or restructured the loans for almost all of its 110 apartment properties. Others in the industry have not fared as well. This year alone, firms from New York-based Tishman Speyer to New York-based AREA Property Partners have watched as their properties are seized by banks or sold out from underneath them. Now, “the worst is behind us,” asserts Jerry Fink, managing partner for Bascom.
Indeed, in recent months, multifamily borrowers seem equipped with a new sense of hope. Recovering prices for apartment properties, strengthening apartment markets, and the growing availability of new financing options make it more possible for multifamily owners to extend and refinance their loans. When it comes to holding on to properties, experts suggest following these six steps.
1. Understand where lenders are coming from.
Things are bad, and understanding just how bad is an important endeavor for an at-risk borrower. In August, the multifamily delinquency rate rose to 13.45 percent, close to seven times where the rate was a few years ago and twice the delinquency rate for office and retail loans, according to New York-based Moody’s Investors Service.
This “flood” of delinquencies largely represents loans that were based on inflated income projections that never manifested themselves—such as the $3 billion mortgage behind New York’s Stuyvesant Town/Peter Cooper Village, which went into foreclosure earlier this year. It is by far the largest single loan on Moody’s delinquency tracker. Or how about the $210 million loan to New York’s Savoy Park? Its loan term doesn’t expire until 2014, yet it’s the largest new apartment loan in special servicing, according to Moody’s.
“Delinquency rate increases have moderated over the past three months, but the overall rate itself is expected to continue rising over the near-term,” says Moody’s managing director Nick Levidy.
A second wave of troubled loans is expected to keep delinquencies rising through 2012. More than $400 billion in CMBS loans will hit the end of their terms from 2009 to 2018, according to Frankfurt, Germany-based Deutsche Bank. Lenders will be swamped with borrowers, many with few options to refinance. At the same time, these loans may be in a better cash flow position than earlier troubled loans.
2. Keep a close eye on prices.
During the crash, prices for apartment properties fell a whopping 40 percent. The Moody’s/REAL Commercial Property Price Index (PPI) for apartment properties dropped from a high of more than 190 in late 2007 down to below 120 in mid-2009. (Note: A PPI value of 100 represents the average price of apartment properties in January 2001.)
This collapse in values has turned many buildings into ticking time bombs. Even with relatively strong occupancies and positive cash flow, properties will eventually hit the end of their loan terms and be required to pay off the loan balance, which in many cases is now higher than the current value of the property.
Since the beginning of 2010, apartment prices have seen some recovery, reaching 135 on the PPI in the second quarter, though that reading is still down more than 30 percent from the peak of the market. “Refinancing becomes a huge problem when values fall more than 30 percent,” says Dan Fasulo, managing director of research for New York-based Real Capital Analytics.
Prices continue to recover, however, and experts hope they will regain more strength before the long-term, interest-only, highly overleveraged loans made at the peak of the boom begin to expire in a few years. No one expects prices to return to their 2007 highs—that would make the entire problem of maturing loans moot. But every increase in prices lessens the amount of money borrowers in trouble could have to contribute to keep their properties. The lower prices remain, the worse the problem facing borrowers when the loan term ends.
3. Start negotiations early.
Most experts advise that, if you need to negotiate an extension for a commercial mortgage, the first thing to remember is to start early—at least six to nine months before the end of the loan term.
But why not get started sooner? “We look 24 to 36 months out,” says George Haase, director of New York-based Centerline Capital Group. That’s when Haase identifies potential problem loans and begins the process of identifying possible solutions. Even with an early start, however, it can be difficult to get the attention of a lender. “Write a letter to the loan servicer saying that you’ve been very happy making payments, and you’d like to continue,” suggests Charles Krawitz, senior loan sales asset manager for Cincinnati-based Fifth Third Bank. Krawitz also suggests including a check with the letter to pay down some of the principal of the loan, contingent on the lender extending the loan for a certain amount of time. “It might help get their attention.”
Bascom’s Fink adds that a 5 percent to 10 percent loan pay-down is becoming par for the course. “They want the borrower to contribute more capital,” he says.
He’s right. Many lenders expect borrowers to have their own money in the deal, to the tune of at least 10 percent. For underwater borrowers, that might mean bringing in a new equity investor, who will typically demand yields of 15 percent to 20 percent, Fink adds.
In exchange for a significant contribution of capital, a balance-sheet lender, such as a bank or pension fund, may be willing to lower the interest rate in addition to extending the loan term. Fink’s renegotiation process effectively re-underwrites the loan, offering the original plan for the property, an explanation of the property’s current condition, and future property plans. With any future plans, Fink suggests that borrowers explain how the extra time will likely increase the value of the property, rather than drag it down.
4. Prove your worth—and that of the market.
In addition to starting early and putting skin in the game, borrowers need to demonstrate their commitment—and skills—when it comes to maintaining the property. For example, the bank might ask borrowers to stop taking distributions from the property or explain how they plan to pay for any needed capital expenditures.
“If the property doesn’t have a good sponsor, that’s problem No. 1,” said Mike Kelly, president of Caldera Asset Management, a multifamily consulting and turnaround services company based in Denver.
What’s more, banks want to know that the property fundamentals are strong. Point to local rental market numbers to show that the property is strengthening and include figures that may affect the potential rental income from the property, including average rents, rent growth, typical concessions offered by property managers, and local occupancy rates.
These are the kinds of details lenders are likely to demand before they extend the term of a loan. It’s a lot compared to last year when the apartment market was so volatile that the valuations of buildings were questionable. At that time, many lenders simply extended loans until the smoke cleared and the dust settled. Now, there’s more scrutiny involved.
5. Know your options—and the decision makers.
In fact, with apartment properties beginning to trade again in significant volume—$2 billion in apartment properties traded in August, the strongest month in 2010 to date and part of a consistent upward trend in volume, according to Real Capital Analytics—few lenders are willing to simply “extend and pretend.”
“Borrowers and lenders have learned a lot,” Fink says. “They know what they can do, and they know what they cannot do.”
And the list of what lenders can do is getting longer. Some are beginning to consider “discounted pay-offs,” in which a lender accepts a partial repayment of the loan balance and forgives the rest as a property is sold or refinanced. However, although lenders will discuss these offers, few have closed so far.
The most flexible lenders to negotiate with are those that have kept the loan on their own balance sheets, such as pension funds, insurance companies, or best of all, local banks. “With a bank, there’s a relationship. They may see you at the country club,” Fink says.
In contrast, conduit loans are much more difficult and complicated to renegotiate—and the process can take up to twice as long. That’s because conduit loans are bundled into loan pools, split into separate tranches of bonds, and sold to investors. With many different investors owning part of the conduit loan, it’s often unclear which investor has the power to make a decision—and the balance of power can shift based on the latest appraised value of the property.
To make matters worse, if the loan is in special servicing, the servicer may not have the staff to handle a renegotiation. “They are overwhelmed,” Fink explains. And the situation can become even more complicated if your financing package included a mezzanine loan.
“The conference calls are long,” Kelly adds. “It’s a shock to the owners that there are so many people in the decision-making process.”
6. Call it quits if it benefits you in the long run.
Of course, not every loan story has a happy ending, and Bascom lost a handful of properties to foreclosure after the crash. (The firm declined to elaborate regarding those properties.) But in some cases, clearing underwater loans out of a portfolio can have some benefits, in that it allows borrowers to concentrate on their more promising properties.
Still, Bascom says its negotiations with lenders have gone well overall—so well that the firm is out buying properties again. In August, Bascom paid $7.9 million, or $26,000 per unit, for a 300-unit apartment community in Denver coming out of foreclosure. The Maples at Crestwood is now close to half-empty and needs as much as $4 million in work. New York-based Centerline Capital Group provided a three-year, $9 million conduit loan, including $5 million to buy the property and $4 million to fix it up.
But the Maples transaction was still a good deal—comparable properties in the area are selling for more than $45,000 per unit, with values continuing to rise. And for Fink, it’s a sign of good things to come. “We are buying properties again,” he says.
Bendix Anderson is a freelance writer based in Brooklyn, N.Y.