Six Ways to Prepare for Potential CRE Restructuring
As the pandemic lingers and unemployment continues at an elevated rate, commercial real estate owners are considering their options for an uncertain future. High unemployment places particular pressure on the multifamily sector. While many tenants have managed to keep their rent payments up to date with the help of unemployment benefits, stimulus checks and savings, the longer their income is curtailed, the more likely they are to default on their housing payment. The threat of reduced cash flow from nonexistent rent payments and possibly higher vacancy rates also makes property valuations less certain.
The latest “Real Estate in a Pandemic: Insights on Dealing with Distress and Loan Restructuring” report from EisnerAmper, an advisory and accounting firm, suggests that CRE investors develop a plan to be prepared for an ambigious period ahead. The report explains that while banks have so far been given lots of leeway to solve short-term liquidity issues, that will change as the national emergency comes to an end. Investors should plan now for the end of regulatory and congressional relief as well as a future in which competition for capital is likely to become even more heated.
“Downturns create a more competitive environment among sponsors as they compete for a smaller and more conservative capital pool,” says Paul M. Fried, Executive Managing Director at Greystone. “A good restructuring plan, at its essence, is the sponsor’s road map, charting a course to accessing the necessary capital. The plan positions the sponsor with its lenders in order to pursue capital in an extremely competitive and demanding environment.”
Steps to Prepare for a Successful Restructuring
- Pay attention to regulatory activity. Following government actions related to CRE mortgages can help you time your negotiations with lenders. According to the EisnerAmper report, whether or not borrowers have already negotiated temporary modifications on their loans, they should carefully consider the need for and timing of a request for additional forbearance or other loan modifications before the expiration of regulatory and congressional relief.
- Do a self-assessment. Investors and lenders will review the strengths and weaknesses of any company, so owners who do a self-assessment can be prepared to face this scrutiny. Fried explains, “In addition to its operating capabilities, the sponsor’s understanding of its submarket, its asset class and its competition, and the ability to draw on meaningful insights into these aspects of the sponsor’s business are important foundations.”
- Gather your information. Review all ownership and debt agreements. Project operating expenses and foreseeable capital needs and potential sources, such as unfunded debt, untapped business lines of credit and equity relationships. Be prepared to discuss the valuation of the physical property, supply and demand in the submarket and to describe the impact of the impact on the property and tenants.
- Develop scenarios based on revenue and occupancy forecasts. If a restructuring is required, says Fried, sponsors will need the support of key stakeholders, particularly lenders. To get that support, sponsors will need to demonstrate that they have analyzed their plan in the context of a variety of scenarios.
- Plan for financial and operational restructuring. Analyzing financial needs such as the potential delay of renovations or efforts to increase turnover to drive rent growth should be accompanied by an operations analysis. Owners may need to change some internal functions, shift responsibilities and implement new systems, goals and practices, says Fried. “Sponsors should be thinking about the aspects of their business that will need to make changes in the event of a deteriorating environment,” he says.
- Communicate with lenders. Preferably, owners already have a strong relationship with their lenders. The EisnerAmper report emphasizes the importance of open communications, particularly by phone rather than email, to facilitate negotiations for restructuring debt. Property owners can propose new terms based on good faith evaluations of their cash flow for the next 12-to-24 months and possibly an offer to pay down some of the balance with funds from the borrower, sponsors or a new third-party investor. In the end, the most important fact is that lenders need to know how and when they will be repaid.
“With planning, forethought and communication, the sponsor is best-positioned to secure the buy-in of lenders, partners, employees, consultants and any other party that stands to be impacted by the restructuring,” says Fried. “That same planning and communication effort can help sponsors maintain reasonable goodwill throughout the process and get the time to execute the plan for the capital they need.”