In the multifamily industry, many eyes will be on special servicers this year. And it’s easy to see why. These firms could potentially provide abundant source of acquisition opportunities. But, if an emerging trend provides any guidance, the buyers of these CMBS assets may not just be getting the apartment. They could be getting some of the debt along with it.
Specifically, a number of special servicers are making asset sales subject to the transference of the current debt on the property. Then, once the sale is completed, they’re restructuring that debt. There are few of these deals happening right now, but they offer enough advantages to expect more to transpire in the future.
“They’re taking over properties without foreclosing and putting them in receivership so that they can maintain the debt,” says Peter Donovan, senior managing director of Los Angeles-based CB Richard Ellis' Multi-Housing Group. “They don’t have capacity under the securitization to offer debt. What they do have is the ability to restructure the debt and rewrite the existing the debt. If they don’t extinguish the debt, they have broad latitude as to what they can do.”
Michael Carp, head of Horsham, Pa.-based Berkadia Commercial Mortgage's asset management and special servicing business says in certain circumstances the existing loan can be split into an A and B note, with the A note holding the value of the asset and the B note with the residual value. "If they perform in accordance with the modification, a portion of the B note can be forgiven," he says.
Donovan has seen this type of scenario as well. “If it’s a restructuring, I’ve seen existing borrower go to an A/B structure where they reset the mortgage and the interest rate gets dropped on the A, which may 110 percent of value,” Donovan says.
The debt could be restructured in any number of areas, including adjusting reserves for structural improvements and leasing, resizing the debt, extending the maturity, and, sometimes, adjusting the interest rates. "We may do an interest-only period, defer the principal, and use the money to establish a reserve," says Stacey Berger, executive vice president at Midland Loan Services, a PNC Real Estate company.
Risks and Rewards
Before Midland decides to accept a restructured note asset sale, it will test the market. "When we take an asset to market, we accept cash and financed offers, to make the decision on what provides the better returns," Berger says. "The special servicer's role is to maximize the recovery of an asset on a net-present-value basis. The sale with financing is one mechanism. It's very asset-specific."
But sometimes, other sources of financing aren’t exactly plentiful. “If it's a multifamily deal, it might not be in condition or have the NOI where you can do financing with a third party like Fannie and Freddie or anyone else,” Donovan says.
But selling with financing has a catch, namely the consent of the current owner. To work out the deal, the owner must agree to the terms. For reputable owners who bought in 2006 and 2007 and got over their heads, this may not be that much of a stretch. "If they have no economic interest left, and they want to preserve their reputation, they may decide to help us maximize value," Berger says.
But Carp says the company has tried to sell properties out of receivership with the existing debt and hasn't had great success. "It requires cooperation on the part of the borrower, buyer, and the court," he says.
Often, selling the asset with the debt can provide the best return as well. It gives bondholders the chance to receive a greater portion of the dollars lent down the road and gives them a chance to lower their losses in the future (instead of exiting the investment with a loss when the asset is sold).
It helps the buyers as well. “They’re able to put 5 percent to 10 percent down on assets,” says Dylan Taylor, CEO of Colliers' U.S. Operations. “But by virtue of the fact that they’re taking a traunche of CMBS, they’re in effect levering at 20 percent to 25 percent.”