Workouts for Underperforming Communities
By: Multifamily Real Estate Industry Team
In an increasingly common scenario in today’s deplorable market conditions, multifamily owners and asset managers are struggling with under-performing rental communities – the communities have declining occupancy levels, are unable to make debt service payments or required capital repairs and are facing the maturity of their existing debt, with no meaningful refinancing prospects on the horizon.
What steps should owners and asset managers consider taking in the near term to preserve their assets and, if necessary, successfully take them through a “workout” transaction?
While any program for an under-performing asset must be tailored to the specific factors affecting that particular asset, the starting point in most situations is to try to identify the objectives that the existing lender will have for the community. For example, some lenders are working extensively with borrowers to maintain the relationships and enable their borrowers to retain their assets. Other banks are accelerating their loans on the first sign of default with the objective of reducing their exposure (especially as market values continue to decline). Loans that have been securitized will likely provide the fewest opportunities for consensual “workout” deals, because the loan servicers that manage these types of loans have little discretion and limited options to modify the terms of the governing loan documents with a view toward helping the troubled borrowers.
Another variable to consider is whether the owner, asset manager or its principals are exposed to any personal liability under guaranties or other loan documents securing the existing financing. In particular, if a guaranty contains a “springing recourse” provision, the guarantors will typically face full recourse liability for the repayment of the entire loan if the owner or one of its affiliates voluntarily files a bankruptcy petition or fails to contest an involuntary bankruptcy filing. Such “springing recourse” provisions significantly limit the options available to the owner of a troubled asset to rely on the bankruptcy laws to “reorganize” the asset since few borrowers will want to risk triggering a guarantor’s personal obligation to repay the entire loan.
Owners and asset managers should review the terms of the existing loan and associated documents to evaluate whether there are any favorable provisions that might assist them in negotiating a workout with their lenders. If the loan documents require any “clean up” (i.e., they contain ambiguities or other provisions that might offer an advantage in the workout negotiations), the owner or asset manager may have greater leverage to achieve a loan extension or forbearance agreement from the existing lender. This approach may provide the owner or asset manager with sufficient time to weather current market conditions and find a take out loan, avoiding a more costly foreclosure for the lender, especially if the collateral securing the loan has materially declined in value.
It is difficult to predict whether a lender will want to pursue foreclosures in the current economic environment. The fact there have been few real estate bankruptcies filed affecting multifamily rental communities in the last year suggests either that most lenders are willing to work with their borrowers or that the most recent changes to the Bankruptcy Code have generally rendered single asset real estate bankruptcy filings to be futile (or maybe some combination of both). On the other hand, if the values of communities continue to drop, lenders may elect to become more aggressive in dealing with under-performing assets.
(This entry posted by Pamela V. Rothenberg, a member of Womble Carlyle's Real Estate Development group, and Jeffrey Tarkenton, a member of Womble Carlyle's Bankruptcy and Creditors' Rights group)
What steps should owners and asset managers consider taking in the near term to preserve their assets and, if necessary, successfully take them through a “workout” transaction?
While any program for an under-performing asset must be tailored to the specific factors affecting that particular asset, the starting point in most situations is to try to identify the objectives that the existing lender will have for the community. For example, some lenders are working extensively with borrowers to maintain the relationships and enable their borrowers to retain their assets. Other banks are accelerating their loans on the first sign of default with the objective of reducing their exposure (especially as market values continue to decline). Loans that have been securitized will likely provide the fewest opportunities for consensual “workout” deals, because the loan servicers that manage these types of loans have little discretion and limited options to modify the terms of the governing loan documents with a view toward helping the troubled borrowers.
Another variable to consider is whether the owner, asset manager or its principals are exposed to any personal liability under guaranties or other loan documents securing the existing financing. In particular, if a guaranty contains a “springing recourse” provision, the guarantors will typically face full recourse liability for the repayment of the entire loan if the owner or one of its affiliates voluntarily files a bankruptcy petition or fails to contest an involuntary bankruptcy filing. Such “springing recourse” provisions significantly limit the options available to the owner of a troubled asset to rely on the bankruptcy laws to “reorganize” the asset since few borrowers will want to risk triggering a guarantor’s personal obligation to repay the entire loan.
Owners and asset managers should review the terms of the existing loan and associated documents to evaluate whether there are any favorable provisions that might assist them in negotiating a workout with their lenders. If the loan documents require any “clean up” (i.e., they contain ambiguities or other provisions that might offer an advantage in the workout negotiations), the owner or asset manager may have greater leverage to achieve a loan extension or forbearance agreement from the existing lender. This approach may provide the owner or asset manager with sufficient time to weather current market conditions and find a take out loan, avoiding a more costly foreclosure for the lender, especially if the collateral securing the loan has materially declined in value.
It is difficult to predict whether a lender will want to pursue foreclosures in the current economic environment. The fact there have been few real estate bankruptcies filed affecting multifamily rental communities in the last year suggests either that most lenders are willing to work with their borrowers or that the most recent changes to the Bankruptcy Code have generally rendered single asset real estate bankruptcy filings to be futile (or maybe some combination of both). On the other hand, if the values of communities continue to drop, lenders may elect to become more aggressive in dealing with under-performing assets.
(This entry posted by Pamela V. Rothenberg, a member of Womble Carlyle's Real Estate Development group, and Jeffrey Tarkenton, a member of Womble Carlyle's Bankruptcy and Creditors' Rights group)
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