Aron Youngerwood
Lucrum Realty
With higher rates and a challenging lending environment, more and more borrowers are seeking to modify their loans or give back their properties to lenders. Recent Trepp data shows thousands of commercial real estate loans becoming delinquent, being moved to special servicing or being put on a lender “watchlist”.
At Lucrum, our debt advisory team have successfully represented borrowers in modifying over $1 billion of commercial real estate loans, including for office, hotels, multifamily, student housing, senior living, medical centers and retail properties.
What Loans are Being Modified?
CRED iQ’s figures show $13.6 billion across 441 securitized loans were modified in 2023. Single Borrower Large Loan deals represented almost 50% of last year’s modifications, followed by CRE CLO deals. Office ($4.6B) and multifamily ($3.3B) loans were modified the most in 2023.
CLO delinquencies have increased sharply with modifications on CLOs backed apartment properties growing significantly quarter-over-quarter according to a DBRS Morningstar report. Apartment owners in the Sun Belt in particular are feeling the pinch, Bloomberg reported, as a glut of new supply hits the market, denting rent growth as loans approach renewal. Office and retail modifications grew at a slower pace, but Loan modifications office still has a higher share than multifamily, with 14.5% of office-backed CLOs modified in Q2.
The Lucrum Team have successfully obtained a number of loan extensions, modified rate cap and escrow requirements, as well reductions of interest rate spreads and other debt relief for clients.
Modify or Foreclose?
In 2023, some lenders preferred to foreclose on properties, rather than agree to loan modifications - but not always with a successful result. As part of the process - when we assist lenders on assessing defaulting loans - and whether we should attempt to restructure the debt, we take a detailed look at the asset and are realistic about future value. Many multifamily lenders believe that cap rates have not moved significantly and believe that foreclosing and holding on to their own books is a better solution then working with a sponsor willing to infuse equity and “work the property” in exchange for a forbearance. In the current interest rate environment, 5 - 6% caps on older vintage or Class B/C apartments may no longer be realistic. The question now being asked by many lenders is "What are the potential pitfalls of direct ownership and what are we about to be on the hook for that we didn't realize?". We have seen instances where the lender had to write off an investment simply by foreclosing and taking direct responsibility for the liabilities they inherited.
Other considerations for lenders as to whether to foreclose or modify include:
Negative Market Conditions: The office, hotel and retail markets have been hard hit since Covid with debt underlying many of these assets in varying levels of distress. The multifamily market has cooled significantly in recent months, with vacancy rates rising and rental growth slowing. This has directly impacted the value of many older apartment properties, especially in Class B & C markets, that are likely valued well below the loan balance. Freddie Mac’s 2024 Multifamily Outlook Report concludes: “We expect the multifamily market to remain sluggish as it works through what will likely be peak deliveries of new supply for this cycle in 2024, with rent growth expected to be positive but below the long-term average and vacancy rates higher than average.” However, if the economy falls into a recession, multifamily would likely see meaningfully lower market performance and declining valuations.
Property Deterioration and Lost Revenue: Depending on the State requirements and, separately, the tactics employed by the parties, foreclosure and receivership proceedings can take months, if not years, to finalize. During this time, the property is likely to fall into disrepair due to lack of maintenance and tenant turnover. This could further decrease the value of the asset and lead to lost rental income, eroding potential returns for the lender.
Reputational Risks: Foreclosure can damage the reputation of both the lender and the building being foreclosed upon. This impacts lender’s reputation in the real estate brokerage and borrower community and future business relationships, affecting future financing opportunities.
Lenders Can Lose Money on Foreclosed Properties
1. During the last housing market crash in 2008, many lenders foreclosed on apartment buildings with values plummeting far below loan balances. Forced sales resulted in significant losses as these properties sat on the market for extended periods due to declining demand. A Government Accountability Office report estimated that Fannie Mae and Freddie Mac lost over $80 billion on multifamily properties acquired through foreclosure.
2. Overestimating Market Value: Sometimes, lenders misjudge the market value of an apartment building and assume they can recoup their losses through foreclosure. However, unforeseen economic downturns, tenant exodus, or property deterioration can drastically decrease the selling price, leading to huge losses. In one case, a lender foreclosed on a $38 million Texas apartment complex, only to sell it for $17 million 2 years later.
3. Holding Costs and Maintenance Neglect: Foreclosed properties often fall into disrepair due to lack of maintenance and tenant turnover. This further reduces the value of the building and incurs additional holding costs such as utilities, insurance, and security. In another case, a bank foreclosed on a California apartment building and spent over $1 million on capex and maintenance before finally selling it at a significant loss.
4. Legal Delays and Costs: Foreclosure proceedings can be lengthy and complex in some States, involving legal fees, court costs, and eviction processes. These unexpected expenses can eat into any potential profit from the sale, especially in cases where the market continues to decline during the legal process. A "Multifamily Executive" article describes a Chicago foreclosure taking over 2 years to finalize, with legal fees alone exceeding $500,000.
These are just a few examples, and every situation is unique. However, these cases highlight the potential downsides of foreclosure and the importance of carefully considering alternative solutions before taking such a drastic step.
About Lucrum Realty
At Lucrum Realty, we have successfully completed over $1 billion of loan modifications and/or restructurings on behalf of our lender. Common loan modifications include extension of loan maturities, lowering of interest rate cap requirements, forbearance/reductions of interest rate spreads, amortization and other loan principal relief, waiver of late fees; allowing a borrower to access existing reserves; waiver of financial covenants and avoiding foreclosures.
Lucrum Realty (www.lucrumrealty.com) provides loan advisory, loan modification and restructuring services for borrowers. Lucrum’s equity platform provides preferred equity and rescue capital for borrowers and lenders to help stabilize a property. The firm’s debt platform is run by Aron Youngerwood, a former CBRE executive who led loan restructuring and originations at CBRE’s debt and investment platform. The Lucrum team includes former special servicers, lenders and restructuring experts.
Please call a member of our team if we can assist you or your clients.
Aron Youngerwood
Tel: 310-785-9491
Joseph Savitsky
Tel: 212-871-8953