Unjustifiable Panic, Cause for Concern, or Both?
There's an article about the state of commercial real estate industry wherever you look. Tenants, property owners, and lenders are facing a changing landscape of office space. COVID-19 changed the traditional work environment, tenants need less space and want better perks in the building, and the value of office buildings has dropped dramatically in many places. If you're a borrower in this economy (or you represent one), you're facing several challenges unique to the current state of the commercial real estate industry. Factors contributing to borrower concerns include cash flow issues, decreased property values, major tenant(s) failing to renew, and loan maturity quickly approaching.
What steps can you take to increase your chances of success? Here are five actions to take right now that can help you avoid a cash trap, full recourse trigger, or default—and stay afloat.
1. Read Your Loan Documents
Borrowers, if you didn't read your loan documents when you signed them, now's the time. It sounds basic, but not knowing what provisions can cause a default can result in serious problems. Many loan agreements and accompanying documents require a lender's prior written consent for something as simple as changing the property manager.
This is especially the case if your loan is part of a securitized pool with complex documents, containing non-recourse and single purpose entity provisions, where if you trip one provision you could inadvertently cause the loan to convert to full recourse against all guarantors. Don't be that borrower/guarantor. Read your loan documents.
2. Call Your Lender Early
The goal here is to help your lender avoid the problem, whether it is maturity, cash flow, or both. And be honest. With a proactive approach and an honest request for assistance to bridge the gap until the sun comes out, most lenders are able to do something to help. Loan extensions or forbearance for those borrowers facing maturity are fairly easy to come by these days, if you are cash flowing and not already in default.
Lenders may agree to a loan modification to relax certain covenants (such as the debt service coverage ratio) so as to avoid a cash trap or actual default. Remember, the lender has regulatory reporting requirements that are impacted by defaults and can cause increased reserve requirements. If a lender is put in that situation, it is harder to be flexible with the borrower. Call them—the earlier the better.
3. Avoid Fast Money
The temptation to borrow more money often ends badly when a borrower is already in a cash flow bind. Avoid merchant cash advances, hard money lenders, factoring companies, and even some mezzanine loans. They'll give you money, but charge an arm and a leg for it, and if you don't pay on time, some engage in invasive tactics to induce collection—not to mention that most commercial loan agreement prohibit subordinate borrowing absent lenders prior written consent. You could put yourself into default with one of these fast money loans, even if the money is applied to your debt.
4. Look for Alternative Solutions
Revisit your budget and see where you can trim the fat. One way to potentially cut a serious cost is to examine the costs related to the ownership and operation of the property. On average, commercial properties are worth less than 60% of what they were 5 years ago. Filing a tax appeal on the building's value might cut a good chunk of expense from cash flow. Don't pay higher taxes on a lower-value building.
5. Hire Experienced Legal Counsel
Chances are pretty good that even if you follow the advice in item #1, it may not help you unless you have a lawyer knowledgeable in the commercial real estate industry, and in complex commercial real estate loans. Your counsel should thoroughly review your loan documents, assess potential pitfalls and default provisions, identify triggers for full or limited recourse (especially for securitized loans), and possess a comprehensive understanding of your loan requirements. If in doubt, always get your lender's prior written consent.
These are steps you can take now to work with your lender, avoid default, and keep your business running until the waves created by approaching maturity dates, declining property values, and destabilized work environment subside.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.