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Dec 03 2009

Overcoming Denial

The most successful workouts begin with developers who recognize problems before situations turn disastrous

By Frank Sasso


Picture yourself as a special servicer. You’ve just been handed a stack of 30 problem loans to review and each situation seems worse than the one before: broken condominiums, vacant office buildings, and apartments with declining collections. Before you even have the time to finish reading, you’re putting out fires, from insurance to tenant issues, and the work is pilling up.

As Tim Hadro of Management Loan Services noted, this is an all too common scenario. However, knowing the challenges faced by special servicers presents an opportunity to shape a mutually beneficial outcome in many workout scenarios.

On November 18, 2009, Mr. Hadro was joined by three other real estate professionals for the afternoon panel of the 2009 Kellogg Real Estate Conference. The panel, Trends in Workouts and Restructuring, was moderated by Biff Ruttenberg, a turnaround expert. Other speakers included Don Resnik, a real estate attorney with Jenner & Block, and John Cadden of CF Capital Partners, providing a developer’s perspective.

Opening up the conversation, Mr. Ruttenberg asked each panelist how best to approach a workout situation involving a broken condominium development. Mr. Hadro noted that the most successful workouts start with a developer who recognizes the problem early and approaches the special servicer with a workout plan, “I don’t have any economic interest left, but I know how to sell condos.”

The upfront approach falls under the old adage that the first step to recovery is admitting you have a problem. Developers can then offer to finish the sell-out while continuing to manage the property for a fee and a portion of the upside if certain economic benchmarks are met. This makes the servicer’s job much easier, helping him to become an internal advocate for the borrower. Conveying that you are the best person, given your understanding of the market nuances and the intricacies of the property, to see the business plan through to completion is key.

“You need to start thinking about a workout strategy before you’re out of money,” Mr. Resnik pointed out. Legal fees are just one consideration. Creative workout strategies often require fresh capital to fund tenant improvements, carry costs, or other fees. The borrower with the capacity to fund shortfalls adds far more value than one who simply does not have the resources. Often lenders will consider writing down a portion of the loan that is underwater to entice new borrower capital.

Beyond the economics, emotions are often a complicating factor that makes denial such an attractive strategy.

“It failed… I had a hard time keeping the ‘t’ in that sentence,” noted Mr. Ruttenberg as he recalled a failed retail development that he had sponsored in the early 1990’s. He recalled feeling personally responsible and tried to do whatever he could to avoid a workout.

Fearing the loss of control, developers often consider bankruptcy as a tool to slow the foreclosure process. One of the most watched examples in the current downturn has been the General Growth Properties bankruptcy. GGP took the unprecedented step of having each individual single-asset entity (Limited Liability Corporations that typically own a single property) file for bankruptcy even though many of these individual mall properties were cash flow positive and covering debt service.

While the legality of GGP’s approach continues to play out in court, Mr. Resnik often advises clients not to pursue the bankruptcy strategy. “Special Purpose Entity bankruptcy only buys you about 90 days [holding off a foreclosure].” Additionally, filing can be a costly, time-consuming process.

Taking a step back from the nuances, the panelists all agreed that these are historic times.

For the first time in history, AAA-rated tranches of Commercial Mortgage Backed Securities are poised to suffer actual losses. Given the non-recourse nature of the loans, CMBS lenders are increasingly wiling to accept discounted payoffs. Everyone seems to be coming to terms with the reality of significantly lower market values.

Mr. Cadden also noted a change in lender attitudes. Given his development background, he is often brought in after the lender takes a property back.

“It’s not like there’s some guy in the back room, someone who knows something that no one else does.” When Mr. Cadden gets called in by a lender to provide a “creative” solution, there is rarely a magic bullet. Like any workout, it’s often a long, slow grind.

While there has been a large gap in the bid-ask spread, institutions are increasingly willing to take the loss and get it over with. Deals are happening, and that’s good news for a workout specialist.

About the Author

This article was written by Frank Sasso.