By Brion J. Kirsch
In the wake of the Congressional Oversight Panel’s February 2010 report entitled “Commercial Real Estate Losses and the Risk to Financial Stability,” forecasting a looming crisis in the commercial real estate market, focus is rapidly shifting to determining ways for commercial borrowers to avoid the foreclosure frenzy seen in residential markets. The report clearly indicates that an increase in commercial mortgage defaults could not only cripple the economic recovery but possibly send the economy into a downward spiral of contraction.
While the report provides ample insight as to what caused this looming disaster and offers a grave forecast of the effect that $1.4 trillion in defaulting commercial loans will have on the economy, the panel has no suggestions about how to avoid this crisis. An idea that has quickly caught the attention of borrowers and lenders alike is the use of commercial loan workouts.
Commercial loan workouts — working with the existing lender to modify the terms of the loan — are ideal for borrowers and/or commercial properties that are either “under water” (meaning that the borrower owes more to the lender than the underlying property is worth) or do not meet the heightened underwriting criteria employed by lenders in today’s climate. The panel’s report estimates that approximately $1.4 trillion in commercial loans are scheduled to mature over the next three to four years. If these loans are not refinanced or extended, they will go into default. Ordinarily, this statistic alone would not give cause for concern. However, coupled with the fact that commercial real estate values have plummeted by as much as 40 percent and vacancy rates have skyrocketed to as high as 18 percent in some regions, it means that many of these loans are under water and consequently could fail. Based on this, there are a lot of borrowers and lenders in need of a solution. Enter the commercial loan workout.
A borrower needs to position itself to be considered for a loan workout, demonstrating to its lender that it will be one of the survivors of this economic downturn. Borrowers that are under water or facing hardships on the horizon cannot wait until it is too late — the key to surviving is to take action now. So what can a borrower do?
• Be proactive — The time to start planning for your loan maturity was yesterday. Time is not on your side during this process. If you haven’t already, immediately begin preparing yourself for a laborious process that will require some difficult decisions. Contact your existing lender and let them know that when your loan matures there may be difficulty in getting refinancing.
• Be realistic — Take a close look at any loan that will be coming due in the next few years. Calculate the debt-service coverage of the property if it had to be financed using today’s appraised value and underwriting standards and begin to contact lenders to see if the property will qualify for a new loan. After examining the true financial condition of the property, many owners may find that alternatives such as foreclosure, deeds in lieu of foreclosure or private equity investments make more economic sense than attempting to modify their existing loan.
• Maintain the property — With rents and occupancy dropping in most markets, many commercial property owners are discovering declines in net operating incomes. In the face of cash-flow shortages, you may be tempted to cut back on preventative and cosmetic maintenance. This could prove to be a big mistake. When trying to extend or modify the terms of your commercial loan the lender will look closely at the physical condition of your property.
• Make a plan — Don’t wait for the lender to tell you what to do. If you wait for the lender to provide guidance, you automatically cede the upper hand. Borrowers who are looking for a commercial loan modification should come to the table with a well-conceived plan that demonstrates the need for help and defines the steps that will be taken to ensure the modification is a long-term success.
• Get help — Commercial loan modifications are a labor-intensive and potentially overwhelming process, which is why retaining the services of an experienced professional is important. Borrowers need an advocate who knows the ins and outs of commercial lending, has experience in loan modifications, loss mitigation and foreclosures to obtain a meaningful and beneficial resolution.
Brion J. Kirsch is an attorney in the real estate department at Pullman & Comley, LLC in Bridgeport. He may be contacted at This e-mail address is being protected from spambots. You need JavaScript enabled to view it .
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