With COVID-19 posing unprecedented challenges, how can commercial real estate lenders mitigate risks and drive results from distressed assets? Curt Spaugh, a SitusAMC Director focused on special servicing, and Ted Wright, a SitusAMC Director specializing in asset management, have decades of experience helping lenders and investors navigate economic cycles. They discuss the outlook for delinquencies and defaults, and strategic options for investors and lenders.
What are you anticipating in the months ahead amid the surge in delinquencies and potential defaults?
TW: The outlook is clearly dependent on when the economy will fully reopen, and when consumers feel safe enough to engage in social interactions and return to their workplaces. Some businesses and apartment households are continuing to pay rent with assistance from the Paycheck Protection Program and unemployment benefits. For example, more than 90 percent of apartment households made full or partial payment by May 20, according to a survey of 11.4 million residential units conducted by the National Multifamily Housing Council. Hospitality and retail have borne the brunt of the crisis, with some publicly traded mall owners reporting rent collections as low as 25 percent in April for indoor properties.
The question is what happens in a few months when stimulus funds are exhausted, though there appears to be bi-partisan backing in Congress for another round of support. In the meantime, servicers are completely overwhelmed with requests for relief from borrowers.
What are the lenders’ options in a default situation?
CS: It’s not a one-size fits all. You have to understand the asset, the players involved and the market dynamics to build a strategy. Some of the options include foreclosing and pursuing legal remedies; liquidating the collateral immediately, typically through an auction process; negotiating a discount payoff with the borrower; or restructuring the debt. Our primary focus is to maximize recoveries for bond holders or individual clients who own the loans on their balance sheets.
Some large special servicers can find themselves overwhelmed in a situation like COVID-19, and their first action is to take back the assets and liquidate immediately. As the saying goes, ‘the first loss is the best loss.’ SitusAMC is fortunate in that we have a robust team of industry veterans who average 20 to 25 years’ experience navigating multiple real estate cycles. We’ve been expanding that team recently to keep up with demand, hiring nine additional individuals. At the same time, we tend to focus on larger and more complex loans compared to our competitors, which allows our experts to go deeper with each client. As a result, we restructure a larger percentage of loans than our peers do.
How do you know when a restructuring is the right strategy?
CS: We start by analyzing the underlying causes of the default. The problem may lie with the asset, the market, or the sponsor. If the issue is the operator, we might pursue legal remedies to get control and run the collateral better. But if not, we’ll look to restructure the debt, modify the loan terms, have the sponsors put new money in the deal so they are motivated to make it succeed, reduce payments for a while and catch up on the back end. We had a lot of success with that approach from 2008 through 2011, though we didn’t see the fruits of our labor until 2014 through 2016.
Can you give an example?
CS: During the Great Recession, we worked with an office operator in California who had a number of loans in default. While the other special servicers went into litigation, we negotiated with the borrower over a period of several months to restructure the debt. It took patience and involved a number of complex structures, but our clients came out whole on their $98 million loan. It’s definitely more work on our end, but in that situation, it was the right approach for the client.
TW: We believe we’ll achieve a higher recovery for our clients if we look at all of the alternatives and develop creative solutions with the borrower versus throwing an asset up for auction. Some special servicers were lauded for “resolving” a large number of deals during the Great Recession, but it’s important to look at the servicer’s complete body of work over the whole cycle to understand what kind of payoff the lenders and investors received in the end.
Why isn’t restructuring always the first line of defense?
CS: Some special servicers appeared to be simply overwhelmed during the Great Recession; they had too many loans to take the time to work out every single one. I remember speaking with a borrower in 2011 who had put together a workout plan but couldn’t get the special servicer to return his call; the property was thrown on the auction block and sold.
TW: We have the capacity to really work these loans and spend the time to do the right thing. We’ve saved lenders and investors tens of millions of dollars by not liquidating at the bottom of the market.