What to Consider When Purchasing Distressed Real Estate Debt

Contact Winston Rowe and Associates

Real estate assets across the United States have suffered the adverse effects of the COVID-19 pandemic and the resulting shutdowns of businesses.

This unfortunate circumstance will present opportunities to purchase the debt encumbering these properties, whether as a way of generating yield, or as part of a “loan to own” strategy.

Whatever the business case, purchasing distressed real estate secured debt presents considerations and hurdles which may not be completely familiar to buyers whose experience lies in purchasing direct interests in real estate.

As the fallout from COVID-19 continues to manifest, some sectors of the real estate industry have been hit harder than others.

Retail properties, many of whose tenants were suffering pre-pandemic from the continued expansion of online shopping, have been hit hard.

Hotel properties have been hit as hard or harder, as many were forced to shut down or severely ramp down operations, either due to legal restrictions or pragmatically given a lack of guests and a need to preserve cash.

Office properties, especially suburban offices, seem to be faring relatively well thus far, as have multifamily properties (although whether that will continue when CARES Act stimuli and state and local eviction moratoria expire is a big question).

Industrial properties may be doing better than any other sector, due at least in part to increased demand for on-line shopping.

Thus far, lenders generally have been working to provide relief to borrowers, especially those whose properties were doing fine pre-COVID-19, including temporary (e.g., three to six month) interest deferrals, extensions of forthcoming maturities and temporary waivers of covenant compliance requirements.

More extensive, longer term loan modifications seem not yet to be occurring on a broad basis, although anecdotally those we have seen typically require some form of collateral enhancement for the lender, such as principal pay-downs, enhanced guaranties, cash collateral reserves and letters of credit, and cash sweeps, among others.

For borrowers with properties which are able to take advantage of these lifelines offered by lenders, such modifications provide an ability to continue to ride out the pandemic storm in the hope better days are not far off, allowing the cash flow and value of their properties to recover.

But what of those properties where the borrowers and lenders have not been able to find a modification solution, whether due to the pre-and/or post-pandemic prospects for the property, regulatory pressures, or otherwise?

Therein lies the opportunity for investors looking to take advantage of situations where lenders prefer to sell off their debt rather than continue to try to work things out or take over the real estate.

If you are one of these potential investors, here are some considerations for when opportunities to purchase distressed debt are available.

Be prepared to assess based on less information

Debt typically is “distressed” because the underlying real estate is having issues, so one key in valuing the debt is understanding those issues. In a “normal” real estate purchase or financing transaction, the owner of the real estate has built in motivations to be cooperative and forthcoming with information about its property and operations.

So, if it wants to sell, or it wants to get a new loan, it will provide potential buyers and lenders much, if not all, of the information it may be requested to provide. This may not be the situation potential investors interested in purchasing distressed real estate secured debt will encounter.

First—be prepared for a situation where on-site due diligence is not available.

In addition to the pandemic related widespread “shelter in place” or “stay at home” orders which may limit traditional on-site property diligence, the borrower may not be willing to grant access for due diligence purposes, and the selling lender may not want to signal to the borrower it is considering selling off the debt even if the borrower might be willing to provide such access.

As for documentary diligence, if previously or currently engaged in workout discussions with its borrower, the lender may have received updated financials on the property, the borrower and any guarantor(s).

But depending on the extent and tenor of those negotiations, some of the information a selling lender may have could be incomplete and/or relatively “stale” by the time the potential investor gets it.

The lender may not even have information on the property beyond what it is entitled to receive under the regular reporting provisions of the loan documents (e.g., monthly, quarterly and/or annual financial reports) – and if the borrower is uncooperative, even some or all of that information may be unavailable.

Additionally, the lender may not have copies of all of the leases (or any modifications entered into without its consent, especially if such consent was not required), and is even less likely to have copies of other relevant property-level contracts, unless it has been able to acquire these items during any workout discussions.

A copy of the lender’s title insurance policy, and maybe even a relatively recent title update, should be available, but an updated survey beyond that obtained at origination is unlikely, particularly in light of the property access issues noted above.

So potential investors should be prepared to “make do” without the array of documentary diligence materials it typically expects to obtain and review in buying or financing the real estate.

Be aware this all could have to be done in a relatively compressed time-frame compared to “regular” real estate transaction as well.

Further, although the lender may be willing to provide certain representations regarding the debt itself in the loan purchase agreement (as discussed below), an investor should not expect a selling lender to provide any representations regarding the underlying real estate to fill in “gaps”, as a seller/borrower might in a property sale or loan origination transaction.

This is not an insurmountable hurdle, just one for which the average real estate investor who has not had much (if any) experience in the recent economy in purchasing distressed real estate secured debt must prepare.

This may mean, for example, digging in deeper into the materials which are available—the monthly and/or quarterly financials, rent rolls, the available major leases, etc. – and doing more cross checking and extrapolating to gain an understanding of the current and future prospects of the underlying real estate (including, if applicable, its tenants).

The less clarity provided by the available data, the more likely the investor may be compelled to build a bigger discount factor into its pricing in purchasing the debt.

How “good” are the sponsors?

Another key in valuing the debt is evaluating the strength of the sponsorship. The available information regarding the borrower, guarantors and underlying real estate obviously will be used to assess the performance and value of the debt and the real estate.

But this information also must be used to assess the sponsor’s ability to address the property’s issues and possibly maintain ownership of the real estate. Put another way, does the sponsor have equity or other exposure to protect, and the financial wherewithal to try to do so?

This is important to assess for the investor whose primary motivation is to purchase the debt for yield purposes—i.e., can the investor, with a lower basis in the debt, figure out a deal with the sponsor on revised loan terms where the current lender could not?

This is equally important for the investor whose primary goal is obtaining ownership of the underlying real estate—i.e., will the sponsor be motivated and financially capable of making it difficult for the new loan holder to exercise remedies to obtain the real estate, or is it more likely to be amenable to giving a deed-in-lieu of foreclosure?

Understand what can (and can’t) be done in enforcing the loan documents

Whether the primary goal is to turn the distressed real estate secured debt into a performing loan on revised terms, or ultimately to acquire the underlying real estate, the investor also must gain an understanding of what the loan documents provide, and the remedies which may or may not be available in the applicable jurisdiction to enforce those documents.

As noted above, the lender looking to off load distressed real estate debt may have limited or imperfect information on the underlying real estate and sponsor, but it should have a complete set of loan documents for the loan it is selling.

The investor should insist on receiving a complete set of fully-executed loan documents (and should confirm each was executed by the proper parties), and confirmation the lender possesses the original note(s) evidencing the loan, before becoming too enmeshed in this process; absence of these basic elements could create significant enforcement and other issues for the holder of the loan.

The investor also should obtain access to the lender’s and any servicer’s loan file, including all correspondence between the lender and the sponsor, which also may impact enforceability of the loan documents (e.g., facts giving rise to potential lender liability claims or other defenses).

Some of the questions to consider in reviewing those loan documents include:

Are there provisions requiring cash management, and have they been implemented?

What other defaults may exist beyond any payment default, and what rights and remedies do those defaults create for the lender?

What reserves are provided for, are they properly funded, and what use can the lender and sponsor make of those funds while a default exists?

Once access is obtained, the investor must assess not only the economic terms, but also the legal terms and remedies available under the documents and applicable state law.

For example, for debt secured by California real property, the state’s relatively unique “one action” and “anti-deficiency” statutes will impact how those remedies may be enforced.

The intricacies of the California framework is beyond the scope of this article, but in simplest terms the “one action” provisions will require a foreclosure (judicially or non-judicially) of the real estate under the mortgage/deed of trust; the “anti-deficiency” statutes, and whether there is a judicial or non-judicial foreclosure, will affect the ability to recover from the borrower and guarantors if the property sells for less than the outstanding debt at the foreclosure sale.

If available in the applicable jurisdiction, a non-judicial foreclosure sale usually may be completed much quicker and more cost-effectively than a judicial foreclosure, but the requirements and ramifications of the options available should be considered carefully.

Also, appointment of a receiver may be advisable to protect the collateral while a foreclosure is pending.

Given the proliferation of lenders requiring special purpose entities (SPEs) own only the subject real estate as borrowers, the guarantor(s) and guaranty(ies) which are part of the loan package are very important.

If there is a guarantor with assets from which to recover, the guaranties supporting the loan can be a source not just of potential value/revenue to support the debt purchase, but also as leverage in accomplishing the investor’s goals.

As noted above, the information available hopefully will provide some indication of the financial viability of any guarantor.

A credit worthy guarantor with exposure under one or more guaranties may be very motivated to facilitate a workout, or to prevent the holder of the loan from exercising remedies, or to facilitate the transition of ownership of the property.

The loan may include a completion guaranty (if the loan has a renovation component, even if the loan otherwise is not a construction loan), a full or partial payment guaranty, an interest and carry guaranty, and/or an environmental indemnity, all of which must be reviewed to determine whether they are enforceable and whether recovery rights have been or may be triggered.

The same goes for any non-recourse carve-out guaranty, which may require the most scrutiny, both as to what the document says, as well as to determine whether any facts exist which may trigger any of the carve-outs.

The factual aspect of this assessment may not be fully possible until after the debt is acquired, so the investor’s initial diligence should be directed towards what “bad acts” are covered by the guaranty, and what level of liability is triggered by each act (e.g., liability only for losses attributable to the carve-out, or full recourse for the entire loan).

Some examples of relevant carve-outs include bankruptcy/insolvency-related events, which often (although not always) trigger full recourse for the debt against the guarantor.

Similarly, a carve-out for interfering with the lender’s exercise of remedies may trigger recourse (full or losses/damages recourse).

These may prove to be sufficient to discourage the sponsor from taking such actions and interfering with or delaying the investor’s desired outcome in purchasing the debt.

Carve-outs for “waste” or misapplication or misuse of funds, before or after an event of default exists, also could prove relevant; events triggering one or more of these recourse provisions may or may not be discernable from the financial and other information available – but those facts may not always be obvious.

A real-world example: while engaged in workout discussions with the original lender, a borrower was able to lease space to a new tenant (which the original lender approved).

The lease required tenant improvements to be paid for by the landlord/borrower; not having enough cash on hand, the borrower’s investors advanced funds.

Ultimately, the debt was sold, and the new debt holder discovered the borrower had re-paid the equity advances from available cash flow while still in default – a violation of the loan documents which triggered recourse for recovery of that cash.

The threat of potential liability for the guarantors created tremendous leverage for the new holder of the debt, and ultimately resulted in the borrower giving a deed-in-lieu of foreclosure (and also paying back some of the funds).

Ultimately, the loan documents, the remedies available under the applicable state law framework, and the facts around the loan and sponsors will affect the outcome for a given loan, so all must be assessed as thoroughly as possible in determining whether and how much an investor is willing to pay to purchase the distressed debt given the investor’s desired outcome.

Other potential factors to consider

Purchasing distressed real estate secured debt also could involve a number of other considerations, some of which could include:

Others in the Capital Stack:

Although this article is focused on potential purchase of a real estate secured loan, mezzanine lender(s) and/or preferred equity holders in the capital stack may have rights and motivations which could affect attaining the investor’s goal. Such players in the capital stack could prove a positive (e.g., another party motivated to step up to help turn the mortgage debt into a performing loan) or a negative (e.g., by invoking rights or taking other actions which could delay exercising remedies to gain ownership of the underlying real estate).

Loan Purchase Agreement:

Negotiating an acceptable agreement to purchase the loan also may prove to be a process different than a typical purchase agreement for real estate.

Although real estate purchase and sale agreements commonly state the property is being sold “as is, where is,” just as commonly the seller will provide a “market” set of representations and warranties the buyer can rely upon (with limitations on survival and liability). In the context of a loan purchase and sale agreement, expect there will be much fewer reps from the selling lender (sometimes limited only to organizational and authority reps, ownership of the subject loan, and the outstanding balance of the loan), with few (if any) reps relating to the underlying real estate or the related information provided, and very limited survivability and exposure for breaches to the selling lender.

Taxes:

Acquisition of the underlying real estate, via foreclosure or deed-in-lieu of foreclosure, may trigger transfer taxes or a reassessment of real estate taxes (although the latter may not necessarily be a negative if the property’s value has declined from the most recent assessment). These factors should be reviewed in the applicable jurisdiction.

Management:

In situations such as the current pandemic, or other general market declines, a third-party manager may have been doing a very capable job, but for those circumstances.

Investors should assess whether continuing current management, under existing or revised terms, makes sense for a given property. In the context of a hotel, for example, an otherwise well-performing management company which knows the property and the market, and has good relationships with a franchisor, could prove to be an asset.

Of course, if the management company has a management contract which cannot be disturbed by a foreclosure/deed-in-lieu or workout, its continued management of the property will have to be factored into the assessment of the property and debt.

Conclusion

In challenging, uncertain times such as these, all investment decisions carry a greater degree of uncertainty and risk. Even in “normal” times, however, the most successful investors are those who best assess and value assets and the attendant risk.

For investors pursuing distressed real estate secured debt, those best prepared and able to execute their strategies by carefully considering the limitations and challenges such as those described above will have the most success.

 

Benefits of a Commercial Mortgage Broker

Hiring a commercial mortgage broker can prove very beneficial, especially if you do not have experience or knowledge about this type of mortgage, the fees involved and terms, among others.

People tend to think that when it comes to real estate or property matters, they should do it themselves only because they feel like it is the right thing to do – after all, it is their own property and there really is no need to involve a third party.

What they do not know is that dealing with real estate issues, especially mortgages, involves tons of effort and a lot of time that it becomes too overwhelming to handle for someone who has absolutely no experience in real estate properties as well as mortgages.

In such situations, getting a broker would be a lot of help.

Here are some of the benefits of working with a commercial mortgage broker:

Because brokers are experienced and they have already established their contacts in the financial industry, they will surely be able to give you expert advice when it comes to your property.

Aside from the advice, brokers can also help you find loans which may fulfill your needs in a personalized manner.

Commercial mortgage brokers can definitely offer you help in getting a loan even if you have a history of late payments causing you to have bad credit rating.

Moreover, since they have a pool of contacts, they have gained access to more specialized information which can be helpful in finding you a loan that has low interest rates and fees.

Looking for a lender that can meet your needs is very time consuming but a good broker can even help you compare the loans offered by lenders so you can choose which one will be more appropriate for you.

When taking out a loan, you would have to prepare various documents, information and forms that are necessary for the application.

This process can be very confusing especially for someone who does not really know where to start and how to go about the whole thing.

Since a broker is already an expert in gathering information and summing up the paperwork, it will surely save you a lot of time and headaches making you capable to focus more on other important work.

When applying for a loan, there are times wherein you will come across legal terms that cannot be avoided for such transactions.

Mortgage brokers will prove to be handy in this matter because they can easily explain to you the legal terms that are way beyond the comprehension of most amateurs.

Given that intermediaries such as agents and brokers do not get paid unless a loan is closed, brokers make sure that they follow the different lending policies of banks and other financial institutions.

They already know which lenders are really funding loans and which ones do not, therefore, they will not waste any of their time or yours applying for a deal with someone who they know won’t close it in the end.

This increases your chances of getting your loan application approved. Brokers will use all their contacts and exhaust all means just so they can close your loan.

 

Insurance Considerations for Real Estate Investors

COMMERCIAL REAL ESTATE INVESTOR FINANCING ONLINE

In any kind of investing, making money is only half the battle. You must also expend considerable effort, time and capital on protecting your gains and making sure they aren’t stripped away from you, whether by an act of God, a criminal act on someone else’s part, or just random misfortune. After all, every successful football team has to have at least a competent defensive unit.

If you’re investing in real estate, getting a great deal will only boost your business if you protect the investment with appropriate insurance coverageWith real estate investing, your offense is your ability to sell properties at a decent price on a regular basis, to acquire properties at a below-market price, and to make appropriate and profitable renovations that quickly add value.

Your defense, on the other hand, is just as important. Perhaps even more so, because while a weak offense will simply make it hard for you to earn profits, a weak defense can leave you bankrupt in a flash.

For a real estate investor, your primary defense is your use of entities to separate your liability-generating assets from your personal assets, and, of course, insurance – and you had better understand both, if you plan to be in real estate for a long time. If you own property, a certain class of people will perceive you as wealthy. Attorneys are circling, trying to earn a bite of flesh for themselves and their clients.

We dealt with entities in a prior column. As an investor, it’s not enough to sit on your laurels, expecting a garden-variety homeowners policy to take care of your protection needs. Indeed, as we shall see, a standard homeowners insurance policy may not provide a flipper any protection at all, if no one is living in the home while you renovate it! Let’s take a closer look at the insurance part of the equation – particularly as it applies to short-term real estate investors.
Liability Insurance

Liability insurance provides protection and liquidity against people who claim to be injured as a result of something that occurred on your property, or a property owned by a corporation or LLC controlled by you.

Note that many of these claims could happen to flippers just as easily as to owners of rental properties. But a standard home insurance policy plus umbrella coverage protection – the “plain vanilla” option offered by most rookie insurance agents, may not be appropriate for your needs.

Why? Because most standard home insurance policies contain exclusions for vacant or neglected properties. To fill the gap, you will likely need a special kind of coverage called “vacant property” coverage, or to buy a rider on an existing homeowners policy, say, if you have a tenant moving out.

You may also want coverage for malicious mischief. This protects you against the kinds of things the neighborhood kids or area vandals and vagrants might commit while occupying your vacant property. Most homeowners insurance will cover this, but not if the property’s been vacant for more than two months while it’s being renovated! This is a specialty area of coverage, and you need a separate policy to protect you.

Dwelling vs. Homeowners Insurance

Generally, real estate investors should be covering their investment properties with dwelling policies, and not homeowners policies. The difference: A homeowners policy covers belongings in the home, too. Most investors don’t need that much coverage. A dwelling policy covers the building itself.

This doesn’t mean dwelling insurance comes cheaper. Typically, any policy designed to cover vacant buildings is much more expensive than a standard homeowners insurance policy would be. You can bid premiums down, however, if the dwelling has a functional fire alarm and burglar alarm system, if you have insulation and climate control in place to prevent pipes from freezing, and other basic risk mitigation measures in place.

Vacancy Considerations

Courts have defined a vacant home to mean one in which there is not enough furniture or appliances to reasonably allow someone to live there. So, if you have a standard homeowners insurance policy, and you have an incident of vandalism or arson that causes significant damage to the home, and it comes out that you had stripped the place bare of furniture and appliances, your insurer could well evoke the “vacancy exclusion” to get out of paying the claim. And they should! Standard homeowners insurance policies are not designed to cover the risks of vacant dwellings, which would drive premiums up for everyone.

To protect yourself, keep some furniture in the unoccupied home so it doesn’t meet the court’s definition of “vacant.” It may be worth renting or buying some garage sale furniture to do this in the short term, suggests Jack Hungelmann of Corporate 4 Insurance Agency Inc. in Edina, Minnesota, and author of “Insurance For Dummies.”

Some policies only cover the actual cash value of the structure, after depreciation. This is generally less desirable than a policy that covers replacement cost. With an actual cash value policy, the insurable value of rental buildings gradually diminishes over 27.5 years, using IRS MACRS rules. (There are other ways to calculate cash value as well.) This is a big deal to rental property investors who hold on to properties for many years. It’s not as much of a concern to a flipper, because if you unload the property very quickly, there’s not much time for the property to depreciate!

Because vacant dwelling coverage is a specialty line, there are no real industry standards. Policies aren’t written to conform to anything like a homeowners HO-2 form. So policies can vary widely in terms of coverage definition, exclusions and price.

For this reason, I would recommend going to an independent insurance broker who is experienced in this type of coverage, and who can write policies for several different insurance companies. This will save you time going over the fine print and comparing the contract language of many different policies from many different carriers, which you would have to do yourself if you went direct with a carrier, or with a captive agent representing only a single carrier.

Construction Insurance

If you have a property that’s under construction, you will also want construction insurance in place. Why? Because chances are good that you will have tens of thousands of dollars in construction supplies sitting on the property during the process – an open invitation to thieves. One of my earlier Flippin’ Insider columns deals precisely with this construction coverage.

Commercial Real Estate Loan Check List Winston Rowe & Associates

Commercial Loan Processing

Winston Rowe & Associates, a national no advance fee commercial real estate advisory and financing firm. Their primary objective is to provide the most reliable and efficient means of sourcing both debt and equity for your commercial real estate loans.

They have prepared this article to provide insight into the supporting documentation needed to perform the due diligence and underwrite a commercial real estate transaction. This is not a comprehensive list of supporting documentation, only a general guideline.

General Supporting Documents Needed For Commercial Real Estate Financing:

1. Last 3 Years Personal Tax Returns (For Purchase or Refinance)
2. Last 3 Years Business Tax Returns (Needed From Seller and Buyer For a Purchase)
3. Personal Financial Statement (For all Guarantors of the Loan)
4. Business Profit & Loss 3 Years (From Seller and Buyer for Purchase or Refinance)
5. Articles of Incorporation (Buyer and Seller for Purchase and Refinance)
6. Schedule of Tenant Leases (For Purchase or Refinance)
7. Schedule of Units With Square Foot Per Unit (For Purchase or Refinance)
8. Resume (For Buyers)
9. Schedule of All Assets Owned (For Buyers and Refinancing)
10. 4506 (T) IRS Form (Patriot ACT Requirements for All CRE Transactions)
11.Purchase Agreement Executed (For a Purchase)
12.TRI Merge Credit Report (For Purchase and Refinance for all Guarantors)
13. Exterior Photos of Subject Property (For Purchase and Refinance)
14. Interior Photos of Subject Property (For Purchase and Refinance)
15. Most Recent Appraisal (For Purchase and Refinance)
16. Current Property Insurance Binder (For Purchase and Refinance)
17. Signed and Dated Personal Financial Statement (For Purchase and Refinance)

Winston Rowe & Associates provides no upfront fee bridge loans in the following states.

Alabama, Alaska, Arizona, Arkansas, California, Colorado, Connecticut, Delaware, Florida, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine,  Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Hampshire, New Jersey, New Mexico, New York, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, South Dakota, Tennessee, Texas, Utah, Vermont, Virginia,   Washington, Washington DC, West Virginia, Wisconsin, Wyoming

No Upfront Fee Commercial Loan Check List Apartments Shopping Center Office Buildings

Commercial Loan Check List

Winston Rowe & Associates has prepared this article to provide general guidance as it pertains to commercial mortgage applicants supporting documentation checklist for apartment buildings, office buildings, shopping center and hospitality.

To speak with a commercial real estate finance specialist you can contact Winston Rowe & Associates directly at 248-246-2243 or visit them on line at http://www.winstonrowe.com

General Supporting Documentation Used For Commercial Loans:

3 most recent years tax returns, personal and business
Extensions for any filings
3 months most recent bank statements, personal and business
Personal financial statements updated within last 60 days
Year-to-date business operating statements-
Year end business operating statements if business tax returns are on extension
Personal resume
Property management resume, or letter of credentials
Letter of explanation for any derogatory credit, including: slow pays charge-offs liens, judgments, child support, etc.
Schedule of real estate holdings
Subject property rent roll
Subject property leases
Subject property income and expense statements, including year end and year-to-date
Commercial Mortgage Loan Purchase Documentation
Valid purchase contract
Selling agent or individual contact information
Verification of escrows
Property insurance information
Title policy
Survey
Property insurance information

Winston Rowe & Associates has a core focus on building long-term relationships, delivering exceptional and individualized customer service, and positioning loan products that best achieve their client’s goals. Their preemptive problem-solving approach is perfect for clients with credit and time sensitive issues.

Winston Rowe & Associates has no upfront free commercial loans in the following states.

Alabama, Alaska, Arizona, Arkansas, California, Colorado, Connecticut, Delaware, Florida, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine,  Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Hampshire, New Jersey, New Mexico, New York, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, South Dakota, Tennessee,   Texas, Utah, Vermont, Virginia,   Washington, Washington DC, West Virginia, Wisconsin, Wyoming