Hot Potato
Oct 1, 2008 12:00 PM, By Elaine Misonzhnik
What if?
With Wall Street in turmoil, the question for retail real estate owners becomes, “How does this affect me?” That question is especially pressing if you have an asset that needs help. Say you bought a small property — with three tenants — and got the acquisition financed in 2006 or 2007. The generous lending environment at the time means that you got almost 100 percent financing and the loan assumed healthy annual rental bumps. In addition, to top it off, the first three years of the loan are interest-only. It seemed like a great deal at the time. Today, however, things are not looking quite as bright. Your mini-anchor closed shop a couple of months ago and then the other two tenants quickly followed. You've got no rental income. And you're rapidly approaching the date on which you have to start paying down principal — not just the interest. In the current environment, there are three possible outcomes.
Scenario 1, Refinancing: The outcome here depends on the kind of loan you got in the first place. If your loan is from a traditional lender, you've got a chance of working out a refinancing. Senior lenders — commercial banks and life insurance companies — are still providing commercial real estate debt, albeit on much more conservative terms. Most likely, to get refinancing you'll have to show that you've got one or more tenants lined up to fill your empty space. Even then, you'll probably only get 60 percent to 65 percent financing. So you've either got to come up with some cash yourself to fill the gap or you have to turn to a mezzanine lender for gap financing. The bright side is that banks in this climate probably don't want to take back your property, so they may give you some time to work things out. Even before refinancing, you may get six months to a year to try and become current on the loan.
Scenario 2: Sale of Distressed Debt: If you've got a CMBS loan, the situation becomes a bit more dicey than if you had gotten financing from a bank or insurance company. You will have to work with a master servicer to try to get an extension, but the process will be more time-consuming and onerous than with a traditional loan because every stakeholder in the conduit will have to agree to any new terms. Moreover, in most cases, issuers of conduit loans are prohibited from reworking the actual financial terms of a loan. In that case, they may give up and sell your loan to a distressed debt investor rather than try to work with you. Your loan may end up in the hands of a distressed debt investor. They may acquire your loan for 20 cents on the dollar. If that's the case, they may not be interested at all in reworking your situation. Instead, they'll just want to recoup their investment plus a little more. They may settle for squeezing 25 cents on the dollar out of you, which would represent a healthy 25 percent return for them. But they are highly unlikely to be interested in helping you do what you can to turn the property around.
Scenario 3, Foreclosure: Try as you might, you just can't convince any tenants to lease space at your now-empty center. You worked with your lender as much as you could. They gave you a six-month extension and then another. But despite your best marketing efforts nothing you did brought any tenants to your property. At this stage, you decide to throw in the towel. The lender repossesses the property. Now it becomes their problem. They either will try to re-lease it themselves or sell it to a turnaround specialist for a song.
Scenario 4, Limbo: What if you decide to throw in the towel, but the lender won't let you? You can't pay down your debt even if you wanted to. You can opt to let the lender begin the foreclosure process. But the lender will have its own challenges. After all, the last thing Lehman Brothers wants right now is troubled real estate to try and turn around. In this situation, the lender may decide to just keep the loan in limbo. You're not paying, but they're not foreclosing either. They're happy with the status quo until the market turns and possible buyers emerge. In the meantime, you will continue to be the proud owner of an empty strip center.
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