The Institutional Real Estate Inc Sponsorship brochure, Connected-Investor Focused, We connect people, data and insights, sponsorship, events, IREI Products
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across commercial real estate declined almost 40 percent, the sector never quite crashed like the housing market. Yes, there were foreclosures and defaults — bank loan delinquency rates exceeded 5.0 percent, peaking at 8.8 percent in 2010 — but not to the scale of the hous- ing market, which was the primary focus and concern at the time. Rather than precipitating a wave of aggressive commercial real estate loan workouts and litigation, banks frequently rene- gotiated and extended the terms of the loans, a process commonly referred to as "kicking the can down the road." is less-aggressive strategy was largely adopted in the interest of self-pres- ervation, as most institutions did not have the balance-sheet strength to fund costly litigation and absorb mark-to-market adjustments that would have been unavoidable in the workout process. Accordingly, little workout-related trench warfare occurred and, therefore, few new workout specialists were minted. On the other hand, a far worse cycle (from a workout perspective) started in the mid-1980s, when commercial real estate loan-delinquency rates stayed above 10 percent for several years — peaking at more than 12 percent — and remained greater than 5 percent until the mid-1990s. is dislocation caused the failure of virtually every savings and loan association in the Southwest, as well as many of the bank holding companies in the Northeast. During this period, unlike the era of the global financial crisis, boards of directors and regulators aggres- sively mandated the full workout of subper- forming and nonperforming commercial real estate loans. is is perhaps best remembered by the creation of the Resolution Trust Corp., a U.S. government–owned entity charged with liquidating real estate–related assets inherited from insolvent savings and loan associations. e RTC, along with other financial institu- tions, bundled billions of dollars of nonper- forming loans for sale, providing the catalyst for the creation of a class of deeply experienced workout professionals, folks who are today in their early 50s. As the distressed-debt markets of this period began to recover, many of these workout pro- fessionals became founders and senior team members of the early 1990s commercial real estate private-equity platforms, several of which continue to successfully manage high-yield value-add and opportunistic debt and equity investment strategies to this day. It is, there- fore, the debt fund sponsors and team members with this type of long, established track record; credit culture; and background that may offer the most relevant and valuable loan-workout skills and perspectives necessary for maximizing recovery rates and minimizing losses. TECHNICAL SKILLS If your existing or prospective debt-fund sponsor is not as battle-tested as those noted above, several technical areas are worthy of further evaluation and discussion with them. In particular, assess their views and experience with the various machinations of (a) the "legal workout" process, (b) the "bricks-and-mortar workout" process and (c) their fund's organiza- tional structure. A key consideration in any distressed-debt resolution is accurately identifying the cause of distress and building estimated cash-recovery models that correctly account for collection expenses and related timelines. Once this is completed, a prudent "legal workout" can be implemented. ere are numerous legal strate- gies and tactics that can come into play, includ- ing debt-for-equity swaps, loan restructurings and modifications, as well as deed-in-lieu, judi- cial and non-judicial foreclosures. e foreclosure process is largely depen- dent upon the law of the state in which the collateral is domiciled. ese laws have a direct impact on the estimated cash recover- ies. When states mandate a judicial foreclo- sure process, it often involves longer timelines and greater costs, given the protection and defense rights typically afforded borrowers, as well as the bottlenecks that often occur at the courts. Non-judicial foreclosure states, on the other hand, can have a more streamlined and cost-efficient process. e existence of cross collateral or other liabilities and creditors can further delay and complicate the legal resolution of troubled loans. Some areas of complexity include the existence of mezzanine debt, secured and unse- cured trade claims, mechanic's liens, delin- quent property taxes, and the like. Of course, if voluntary or involuntary bankruptcy is added to the mix, there are endless considerations to be made that are far too voluminous to outline here. Nonetheless, does your debt fund spon- sor have internal knowledge, experience and viewpoints on these matters? If the debt fund sponsor is successful in navigating the complexities of the "legal work- out" and ultimately achieves ownership of the collateral, do they have the skill set and core competency to operate the property and maximize residual value (i.e., the "bricks-and- mortar workout")? To optimize success, a firm should have meaningful, direct commercial real estate ownership experience, without the assistance of joint-venture operating partners, and should demonstrate this experience across multiple property types and geographies. Hos- pitality, retail, office, industrial, apartment and 55 REALASSETS ADVISER | D E C E M B E R 2 0 1 8