Tanya Little

The economy continues to present unique challenges to commercial real estate borrowers and holders of CMBS loans. Many have defaulting loans, which, often, are not the result of poor business decisions, but more a product of the year they were initiated or, in some cases, the maturity of “extend and pretend” loans.

According to Moody’s/REAL Commercial Property Price Index, commercial real estate prices increased 90 percent from 2001 to 2008. The result throughout this recessionary market was that defaults accelerated from 1-10 percent in 2008 and are expected to rise to 12 percent by year-end 2011, according to Moody’s analysts.

With banks holding on to distressed real estate, and billions in special servicing and early CMBS maturities coming due, it could take years to rebalance these assets either through restructures or foreclosures. As a result, a massive amount of real estate will eventually flood the market or trickle out through a prolonged period of economic stagnation, which is not a favorable outcome for most.

So, what are your alternatives to an over leveraged loan coming due? You’ve lost your initial equity, markets are seeing some recovery—but not fast enough to even cover the debt—and partners are hesitant to invest new equity.

For CMBS, there may be many choices, such as payment relief, debt deferral, debt forgiveness, or extensions; but it can be difficult to know which modification or combination of debt restructuring is right for your situation. Creative hybrid variations are also available.

Despite all of the market talk about CMBS, special servicers and distressed debt, modifications are getting done. Generally, servicers are looking for a modification which creates a win-win scenario for the borrower and the trust. In some markets where recovery isn’t perceived until after the loan life, resolution can be more favorable. The following is an example of a note restructure combining several options:

A large retail center had serious cash flow shortfalls due to the loss of tenants, tenant concessions, and overall market conditions. The value of the real estate at the time of the restructure request was approximately 50 percent of the loan amount, and it was a CMBS loan, originated in 2006. The special servicer agreed to an A/B split, where the A note was equal to the current value of the real estate (or approximately half the original loan amount). The remaining loan balance became the B note.

At time of sale or refinance, the liquidation waterfall will be applied as follows:

• First, full payoff of the A note,

• Second, repayment to the borrower of any new capital infused after the restructure date plus a preferred rate of return equal to the note rate, and then

• Split of the remaining proceeds 50 percent to the borrower and 50 percent to the CMBS Trust.

From the inception of the loan, the collateral property typically operated at a debt-service coverage ratio exceeding 1.5x, with occupancy hovering in the 90 percent range. With the advent of the credit crisis and the lack of tenant base, the borrower faced receivership and foreclosure on its property unless it could take out the existing loan upon maturity.

The partners were willing to contribute additional capital to fund additional reserves for future lease-up costs in order to re-tenant the site and make it more financeable.

Lastly, the servicer granted a one year forbearance of the loan maturity with default interest accrued and forgiven at the time the loan is refinanced. The borrower remained in control of the site with the ability to enhance the property’s value, thereby offering a new lender a more attractive form of collateral.

There is no “one size fits all” when it comes to restructuring loans. Assets clearly are unique in nature and each resolution is evaluated and underwritten thoroughly. These structures continue to evolve as the market continues to improve, but there are clearly still options for borrowers.

Tanya Little is managing director of 1st Service Solutions and founder and CEO of Hart Advisors Group LLC. Contact her at tlittle@1stsss.com.