Some assets don’t even generate sufficient cash flow to cover the existing debt. New construction or expansion properties that are not meeting their pro forma income and occupancy projections, for example, may face significant hurdles due to weak demand and softening rent. Likewise, properties acquired or built in the last three years (during the market’s peak) with short-term, high-leverage debt are likely to be more affected by today’s conservative cap rates and debt terms.
The sad reality is the value of many troubled assets is below the existing loan balance. Whereas cash-flowing properties with near-term maturities may face an equity gap, a more severe classification of under performing assets likely has no remaining equity at all.
If you find yourself in the unfortunate situation where the loan balance is greater than the property’s value, you may be facing an uphill battle, but all is not lost. In this scenario, you are likely headed for a workout with your lender. If so, in addition to the steps outlined earlier, consider these additional strategies.
Gather all your loan documents and review them. Make sure you have a good understanding of their contents. In addition, seek competent advisors to guide you. Regardless of the type of loan you have, it’s likely you will benefit from the services of competent legal counsel.
Depending on your loan type, you may also need a loan-workout advisory service. These advisors will cost some money but should help minimize the long-term damage. It goes without saying that all consultants are not equal, so check references and make sure you hire competent and experienced advisors.
Financial-Term Modification Options
Ask for an interest-rate reduction or, if the loan can be converted to interest-only, ask to lower the loan payments to a level that allows the property’s existing cash flow to service the debt. Although it may seem nonsensical that a lender would consider these requests, make the case that he stands to lose less money through this structure than other alternatives such as foreclosure.
See if you can extend the loan’s maturity date. Time can be a great asset and heal many ills, but that requires the lender’s cooperation. If all parties agree and believe in the potential of the asset, this can often be an easy solution.
Reduce the outstanding principal balance to an amount equal to or greater than what the lender would receive through foreclosure and quick sale. If the lender believes in the current ownership, this may be a cheaper and less messy alternative.
Modify the Equity Structure
You might not want a partner in your business, but bringing in an additional guarantor with superior financial strength could boost the lender’s confidence that the loan will be repaid at maturity.
Alternatively, if the means exist, reducing the principal balance with a cash infusion from a new partner can rebalance the deal and allow the property’s cash flow to service the debt going forward.Another strategy is to offer the lender participation or a future equity kicker in exchange for modifying the loan.
Gracefully Exit the Deal
Conduct a short sale in which a buyer purchases the property at a price less than the principal balance. Again, this may not seem realistic on the surface, but if it’s a market deal, the lender avoids foreclosure costs, and the borrower potentially avoids future negative implications caused by foreclosure.
Another method is to cooperate with the lender to forgive your personal guarantee by handing the property over via Deed in Lieu of Foreclosure, as opposed to fighting foreclosure through bankruptcy. This minimizes the potential of the lender seeking your other assets for repayment.
Shawn Hill is a principal at The BSC Group. He is responsible for advising clients regarding debt and equity financing and providing loan-workout services for all commercial property types, with an emphasis on self-storage. He can be reached at 773.517.8504; e-mail firstname.lastname@example.org.