Options for Struggling Operators/Investors

[Kyle A.]

I'm sure you all saw in the news last week another heavily Texas based investment team (Tides Equities) is facing loan maturities amounting to $1.5 Billion (with a B) backed by poorly performing properties, that will require massive cash calls or rescue capital to avoid foreclosure. Unfortunately it's likely they will join Applesway as the next big failure in the commercial multifamily space. 

As we come closer to the end of this year and into the next couple, these will not be unique situations. According to Fitch Ratings, 23% of CMBS debt alone will be maturing by the end of this year are too highly distressed to have a chance at refinancing. Yardi Matrix shared data of 2500+ underperforming commercial multifamily properties yielding <1 DSCR, that happen to be on floating bridge debt expiring this year. The fed has stated the likelihood of at least 2 more additional hikes this year, which will push these properties even deeper underwater.

Here are some potential options operators can take if they are facing loan maturities with struggling properties:

1. Cut Costs - Obviously the first course of action. Cut costs wherever possible in order to boost profits. Note that if documented proof of effort to boost NOI is not shown, many banks reserve the right to convert non-recourse debt into recourse, leaving personal assets outside of LLC at risk.
2. Notify Limited Partners That More Equity Is Needed – Whether looking to raise more capital outside of the current partnership, or within, fill in all investors with what’s going on. Depending on how recently the property was acquired, there might be an addendum that needs to be signed in agreement by all investors allowing the ability to raise more outside capital to be raised. This can take time so better to do it sooner than later.
3. Loan Personal Capital – If operators have the ability, they should loan their own personal capital to keep the project afloat. They can also collect interest on this loan, so it is not only a show of good faith in their abilities, but also goes back to putting in good faith effort in boosting NOI. If they have the ability and do not do so, this will not go over well with banks or investors, and can result in lawsuits.
4. Sell More Equity – This is a tough sell since you're essentially trying to bring in more investors to a bleeding property, but it is more favorable than doing a cash call with limited partners already invested into the deal. This is easier to do if everything has been going according to plan and NOI is close to, or exceeding projections.
5. Reallocate Cap Ex Budget to Reserves – If there’s money left that hasn’t been used, it’s possible the bank will allow you to move the remainder into operating reserves to stem the bleeding. This isn’t initially favorable to banks, so you must provide a great argument for this.
6. Borrow Money Against LP Shares – Using limited partners invested equity as collateral is an option, and if they’ve gotten to this point, the LP shares are already at risk so operators might as well put them at stake to try and save the property.
7. Borrow Money Against GP Shares – This is even less favorable and more difficult to do than borrowing against LP shares, which is why it comes after.
8. Cash Call – Ask for more equity contributions from limited partners currently invested in the property. They should be fully informed of the state of their investment at this point, and should not necessarily come as a surprise. Most will not want to invest additional funds if it looks like a sinking ship, but if there has been thorough communicating, property has been going according to plan, and is only at risk because of interest rates, maybe some will be on board.
9. Rescue Capital – This can come from boutique lenders or other investors/operators. There’s multiple ways to structure this, and of course every project and situation will have different terms. There’s a version where rescue capital is brought in to essentially refinance the property into fixed debt, but will also take control of the asset as well as take pref equity from investors. There’s another version where rescue capital comes in to cash flow the property to keep it afloat while remaining on the existing debt. This could be a better option if a refinance isn’t feasible and the bleed of the property isn’t too substantial. With the second version it’s typically a note that converts into equity once property is stabilized.
10. Sell Property At A Loss – As stated above, the fed already announced there will likely be more rate hikes this year. If there is not a conceivable course of action and none of the above steps are successful, this is the next best option. Allowing a property to fall even further victim to rising interest rates and decompressing cap rates is extremely irresponsible and waiting will cause even further losses or foreclosure.
11. Foreclosure - No banks yet have allowed principal deferment, payment deferment, or temporary rate adjustments yet and are not afraid to seize properties. They will take back control and easily sell it for sub-maximal price as long as owed loan amount is covered. If banks are threatened by delinquencies, they see risk of losing money, and lack of effort by operators to restore profitability, they would rather take back property and sell it themselves instead of watch the value sink even more. They will not help investors get their principal back, whereas rescue capital can. Going into default and bank seizure is worst case scenario and the laziest option for operators and investors.

So what are the takeaways for buyers not in these situations? No matter how competitive a market is, always stick to the fundamentals to mitigate as much risk as possible to avoid serious loss. Know your risk tolerance, and every corner you cut to make a deal pencil out (when it really shouldn't have) leads further and further away from risk mitigation. This should be most pertinent with syndicators or operators taking on investor capital in any form. I don't see a problem with gambling your own money, but taking huge risks with other peoples money is irresponsible and reckless. What's going to happen in the coming years is really unfortunate for our industry, but hopefully we are able to learn and come out better on the other side.