| It's 7:00 AM. Someone needs a wakeup call. It is still | | | | commercial real estate market. Consequently, after |
| early, but getting late. | | | | the economy has hit bottom and begins to turn |
| These are tough times, no doubt about it. But just as | | | | upward, recovery is likely to take place at a slow |
| investors, lenders and developers deluded themselves | | | | pace over an extended period. |
| over the past several years into believing the good | | | | It is an absolute certainty that the market will |
| times were here to stay - so, too, are they | | | | eventually hit bottom and turn upward. This is as sure |
| misreading the future now. | | | | to happen as Annie singing "the sun will come out |
| NEWSFLASH! This market will hit bottom. This market | | | | tomorrow". You can bet your bottom dollar that the |
| will turn. The credit freeze will thaw. The commercial | | | | commercial real estate market will rise again. |
| real estate market will rise again. | | | | Unfortunately, it will not happen overnight. Once deal |
| The question is: How are we going to position | | | | flow starts to develop, property values will begin to |
| ourselves for the balance of this economic cycle? | | | | rise. Perhaps counter-intuitively, this is where |
| Certainly, to get to the other side we have to | | | | distressed borrowers who have not negotiated a |
| survive the downside. But, really, we need to look | | | | meaningful loan workout agreement in advance will |
| past the ground immediately in front of us. We need | | | | get hurt. |
| to raise our eyes to the economic horizon to see | | | | Here's why: |
| where we are headed, then plan to get to there, and | | | | Assume a project was worth $25 million before the |
| move beyond it. | | | | current crash, and has an outstanding mortgage of |
| We don't need a crystal ball to see the future. Those | | | | $20 million, but today the property would fetch only |
| of us who have been in this industry for thirty years | | | | about $14 million. The investor started with equity of |
| or so have been through this before - at least a | | | | $5 million. Today, the project is upside-down by $6 |
| couple of times. We know the cycle. We need to | | | | million. Some borrowers seem to believe that when |
| heed the lessons history should have taught us. This | | | | the market turns and starts going up again, lenders |
| is no time to pull the covers over our collective heads | | | | will continue to grant short term extensions into the |
| and hide - hoping we will soon wake up from this | | | | future until the project value fully recovers so the |
| horrible dream. | | | | borrower can regain its equity. The reality is, it is not |
| Right now the commercial real estate market is | | | | going to happen that way. |
| stalled. We all know that. Vacancy rates are climbing. | | | | Lenders are not going to wait around for the |
| Credit is tight. Loan defaults are rising. Borrowers and | | | | property value to rise to $25 million as it was before |
| lenders are stressed. There is a general uneasiness | | | | the crash if they don't have to. They won't have to |
| about where we are and where we're headed. Deal | | | | unless a long term extension is negotiated now. |
| flow has dropped to a mere trickle. | | | | As the market picks up and property values start to |
| Our industry is so constricted right now, an eerie | | | | increase, the borrower is destined to lose out. As |
| calm has settled upon us. | | | | soon as a third party comes along and lets the lender |
| Borrowers are in default, but lenders are not | | | | know it is willing to buy the project or the loan for |
| aggressively seeking to take control of their collateral. | | | | anywhere near the $20 million balance of the loan, |
| Let's face it, in this market, what is our lender going | | | | the borrower has lost all of its bargaining power. The |
| to do with our project that is any better than what | | | | lender will not likely grant that next 30, 60, 90 or 120 |
| we are doing with it? Sell it? To whom? And on what | | | | day extension. Instead, the lender will very likely |
| terms? Appoint a receiver to take possession and | | | | declare a default and force a sale for an amount |
| control? If professional property investors and | | | | necessary to satisfy the loan, but no more. That is all |
| managers with an equity stake can't make these | | | | the lender cares about. The lender will get out when |
| projects cash flow, is it reasonable to expect that a | | | | it can. It will not take the chance that the market |
| foreclosing lender will fare any better? | | | | may drop again. If the borrower has failed to act to |
| What about their other choice, which is to enforce | | | | protect itself while it is in a position to do so, the |
| personal loan guarantees? How much of the income | | | | borrower will have lost any opportunity to recover its |
| stream and net worth that gave those guarantees | | | | investment. Even worse, the Borrower may have, in |
| value is still available? | | | | the meantime, drained other investments to keep |
| No. The answer right now is loan modification and | | | | interest payments current for naught. |
| loan restructuring. Most banks accept that a modified | | | | In order for borrowers to protect themselves they |
| loan yielding a lower return but receiving regular | | | | need to get to the negotiating table now, while |
| payments is better than a non-performing loan | | | | lenders still have something to lose. Now is the time |
| receiving no payments. | | | | borrowers need to act - while lenders are stressed |
| BORROWERS TAKE NOTICE: As bad as this down | | | | and fearful and motivated to deal. |
| economy is, it presents a whole host of opportunities | | | | Why are borrowers holding back? |
| to modify loans in a way that will make these | | | | There are a variety of reasons cited by borrowers |
| troubled projects more profitable on the other side | | | | for not aggressively seeking to renegotiate their |
| of this cycle. What is possible depends upon variables | | | | loans right now to protect them in the future. |
| inherent to each loan and each project. | | | | Many are simply in denial or in a state of psychological |
| There are any number of potential workout solutions | | | | paralysis from the shock caused by the swift and |
| to which a borrower and lender may avail | | | | largely unexpected decline of our economy in general, |
| themselves. No two loans and no two projects are | | | | and the commercial real estate and credit markets in |
| exactly the same. One solution will not fit every | | | | particular. |
| circumstance. Each solution must be tailor made to | | | | Others are holding back through fear that if they |
| meet the respective, and often conflicting, needs of | | | | start actively discussing the topic with their lender, |
| the lender and borrower. | | | | their situation will come to the forefront in the |
| Why would a lender agree to any of this? Certainly | | | | lender's mind and the lender may commence |
| not because they feel compelled to help their | | | | aggressive action to collect. This reasoning seems to |
| borrowers. No, there is nothing altruistic about it. Plain | | | | be founded on the notion that maybe the reason |
| and simple, it's because lenders know that in this | | | | lenders are not aggressively pressing borrowers for |
| economic climate they are likely to end up recovering | | | | payment to forestall enforcement and foreclosure |
| more through a negotiated restructuring than they | | | | action is because lenders are so busy putting out |
| will recover if the borrower simply gives up and | | | | other fires they don't have time to focus on this one. |
| walks away or files bankruptcy and sells the property | | | | It is highly unlikely that this is the dynamic at play. As |
| free and clear of all liens, claims and interests through | | | | mentioned above, the reason lenders are not |
| a pre-packaged sale pursuant to Section 363 of the | | | | proceeding aggressively at this time is because the |
| U.S. Bankruptcy Code. Now, more than ever, lenders | | | | market is no better for them than it is for us. They |
| recognize that cooperating with borrowers to | | | | don't want to own our projects and get stuck with |
| restructure a distressed loan in a way that keeps the | | | | the headache of managing projects that are not cash |
| borrower operating the property may be the only | | | | flowing and cannot be sold. They are biding their |
| sound and prudent choice they have to maximize | | | | time, waiting for economic conditions to improve so |
| recovery. | | | | they can get out whole, or close to it. |
| Borrowers are missing the opportunity they now | | | | The other reason I hear from borrowers is that |
| have to negotiate with their lenders to achieve loan | | | | negotiating a successful loan workout requires |
| workouts that can give the borrower a realistic | | | | competent legal counsel skilled at workout |
| chance to get out of this mess. Lenders are willing to | | | | negotiations. The borrower is already financially |
| deal now, to avoid major write downs and to avoid | | | | distressed. Even the thought of incurring the |
| having to carry defaulted, non-performing loans. | | | | additional expense of hiring a lawyer is almost |
| For many borrowers, any indulgence a lender gives to | | | | unbearable. |
| forestall foreclosure seems a blessing. Financially | | | | The obvious defect of this reasoning is that it is |
| distressed borrowers are only too happy to accept | | | | short-sighted. If resources can be reallocated now to |
| these stop gap solutions to buy temporary peace. | | | | work out a long term solution, the chance of pulling |
| Many distressed borrowers are failing to take | | | | out of the current financial death spiral increases |
| aggressive steps to benefit from opportunities that | | | | dramatically. If borrowers continue living on borrowed |
| exist. The certain outcome of this inaction is that | | | | time with only short term, stop gap solutions, it is a |
| borrowers are setting themselves up for future loss. | | | | virtual certainty they will ultimately lose their equity |
| Borrowers are simply misreading the patience many | | | | and, perhaps, remain liable to pay additional funds |
| lenders are currently showing. | | | | under their personal guaranty. |
| It is true that many lenders are being cooperative by | | | | To say the least, this is being penny wise and pound |
| extending loan maturity dates and lengthening default | | | | foolish. |
| cure periods. Borrowers appear to believe these | | | | I know. This may sound like a tremendously |
| lenders have found a heart. Borrowers are thankful | | | | self-serving statement coming from an attorney who |
| for the 30, 60, 90 or 120 day extensions they are | | | | represents borrowers in loan workouts. A point well |
| receiving. To obtain these brief extensions, some | | | | taken. But consider this: I am not saying you must |
| borrowers are draining cash flow or equity from | | | | hire my law firm. While I genuinely believe my firm |
| other projects or investments to keep interest | | | | offers a unique value proposition that may serve you |
| payments current, which is often the only | | | | well, hiring my law firm is not the point. Really, you |
| requirement their lender is insisting upon during these | | | | just need to hire someone - anyone - who fully |
| troubled times as a condition to granting loan | | | | understands the issues, understands the possible |
| extensions. To hear many borrowers talk, they are | | | | workout scenarios and who has experience resolving |
| convinced their lender will continue to work with | | | | conflicts with lenders. If you have worked with other |
| them until the market turns and recovers, when the | | | | counsel who can do this, then hire them if it makes |
| borrower and lender can both return to Xanadu and | | | | you feel more comfortable. Just get started. The |
| live happily ever after. | | | | longer you wait, the worse it will get. |
| Ring! Ring! Ring! This is a wake up call. It is NOT going | | | | In all events, we wish you the best of luck. Like it or |
| to happen that way. Unless we act now we will lose | | | | not, we are all in this together until our industry |
| this opportunity to save our property and salvage | | | | recovers. |
| our investment. | | | | Over the coming months, exercise caution, be safe, |
| Here's how I see it: | | | | and do what you can to position yourself to prosper |
| There is not going to be any single event that will | | | | when the market rebounds. Keep the faith - it will |
| cause a reverse Lehman effect, resulting in a sudden | | | | rebound. We want to see you on the other side. Until |
| loosening of credit and prompt rebound of the | | | | then . . . |