Todd Goulet, senior vice president with KeyBank Real Estate Capital in Cleveland, has been getting a lot of desperate calls lately. In fact, he says about 25 percent of the apartment owners who call him are in trouble.
Just three years ago, buying an asset was easy. Get 75 percent financed from a lender. Pull in an equity partner and mezzanine debt. Suddenly, you have an apartment with nearly no money down. In doing so, seasoned real estate and financial managers pulled the same shenanigans as Joe Subprime down the street. They took large bets on real estate, assuming the market would bail them out if they got in trouble. Instead, the market has plummeted.
"[Apartment owners] over-leveraged on their existing debt, and it's a challenge for them to get out," Goulet says. "I can see why borrowers are becoming concerned."
They should be concerned?many properties with loans maturing this year will likely not be able to refinance. But that doesn't mean there aren't options out there. Here are four tips.
1. Start Talking. Now.
If you have a maturity due this year, Donald Phillips, sole owner and managing director of Phillips Development and Realty in Tampa, Fla., says you need to pick up the phone. Now. "We're encouraging people to start talking to their lenders about anything coming up in the next 12 months," he says.
Getting in early can also tell you exactly who owns your loan. That's what Ryan Akins, regional manager for The Bascom Group, discovered when he started working to renegotiate loans on nine of the Irvine, Calif.-based owner's Texas properties with loan maturities in 2009. "In some cases, it could be foreign investors," Akins says. "CDO's [collateralized debt obligations] were sold all around the world. The special servicer represents the CDO."
Unfortunately, just because Akins is finding out who owns the loans doesn't mean he's getting a load of help in changing the documents. "That special servicer is bound by the documents of the CDO fund," he says. "It's not like they can go back to the original investors. Any renegotiation has to fall within the walls of those original documents."
But if you see familiar faces, the renegotiation will go better. "If we're dealing with the same people that we worked with on the front end of the loan, it makes it a lot easier than if we're working with a completely new group of people and have no relationship with them," Akins says.
2. Be Realistic.
When Goulet begins talking to apartment owners and developers who call him for advice, he often says the same thing: Put more equity into the deal. "They don't like hearing us tell them [that]," he says.
That's probably because many of them don't think of their assets as troubled. "I think a lot of owners still think that they can rescue the project," Goulet says. "They haven't bought into the idea that their equity is just going to get worse."
Others agree. "The natural human response is that people do not want to face the reality that the property lost 25 percent value or less," says Chad Ricks, first vice president out of St. Louis-based Love Funding's Dallas office. "They don't want admit it to themselves."
But the sooner they understand their property is in trouble and start looking for reasonable ways to solve the problem, the better chance they'll have of saving it. "Over the past six to nine months, anyone that passed on a deal they had and came back looking for another one, has regretted that decision if they're looking for maximum loan proceeds," Goulet says. "If you have a deal now that works for you, you should take it. If you come back in the future, it may not work anymore."
3. Find Money.
Once loan holders realize they're in trouble, they'll usually act. "Typically, they'll go out and scour the world for other options," Goulet says. "Ultimately, they'll realize that the options to get debt at the level they need will be very expensive. That's when they come back and say, 'OK, what are my options if I can get that Freddie or Fannie first mortgage debt, which is the cheapest in the market? What are more options for mezzanine debt?"
Goulet says that both Freddie Mac and Fannie Mae have been receptive to adding mezzanine debt. But the mezzanine requirements might be too onerous. "Mezzanine debt, which is typically 15 percent these days, can strap your cash flow with too much debt," Goulet says.
And, if you think you'll get mezzanine debt up to your property's previous value (before cap rates rose), Bob Hernandez, senior vice president and managing director of Minneapolis-based NorthMarq Capital's Minneapolis office, thinks you need a serious reality check. "They may bring income in and do mezzanine and equity at the new value," Hernandez says. "They won't put in mezzanine to the old level."
If mezzanine proves to be too onerous, equity can be an appealing alternative, especially with a partner you already know. "If you have a relationship with someone you've done business with before, bring that person in as a new equity partner to recap your partnership and include the equity in the deal," Goulet explains. "That way you can put on the new debt [even though] you're losing a share of the deal. It's better than selling it."
Hernandez thinks bringing in an equity partner is probably the best outcome an operator can get. "If you don't have the money, invite a partner, have management fees, you don't have a default, and you still get to share in the equity," he says.
Ricks, who pitches FHA renovations loans if the property warrants them, sees issues with adding both debt and equity. "With mezzanine and private, we've noticed that both are more expensive," Ricks says. "There's less equity than their used to be, and it's the same with mezzanine."
4. Get Rid of It.
If there's no debt, there's little equity, and refinancing isn't in your future, then you're probably not going to have the asset in a year. So the question becomes, do you hand over the keys to the bank or give it away at a discount?
Goulet says that's an easy decision. "You'd rather turn the keys over to the bank than sell it for a loss," he says. "If you can sell the property for nothing more than existing debt, you'll lose equity."
But the numbers matter, of course. If, for instance, your debt on a property is $16 million, while your cost is $20 million, you can sell it for $18 million, then limit your new debt at $14 million, and pull $2 million of equity back.
"Selling it and losing some equity is probably a better option than turning over the keys and losing all of your equity," Goulet says.
Of course, everyone out there is looking for a deal. Because of that, the sales price you get my not necessarily be what you want. "Pricing is down and it's been going down further throughout 2009," says Matt Wanderer, president of Alterra Capital Group, an apartment owner in Miami. "Everyone is in consensus that 2009 will be a down year."
That's why there may ultimately be no good options for people who can't save their properties.
