Commercial Loan Workouts and Modifications

By Chuck Matheny

Commercial Equity Solutions, LLC


Many commercial borrowers now find themselves in the same condition today that a significant majority of homeowners are in. These commercial borrowers have negative equity or in other words their loan is greater than the value of their property. What is worse is that often the income from the property is not sufficient to pay the monthly debt service and taxes due on the property. This poses a problem when it comes to the end of the term of the loan and a refinance or extension is necessary. It also causes a more immediate problem of how will the commercial borrower pay the monthly loan and tax obligations.


This situation has evolved in most cases for two reasons; 1) the economy has caused many business’s to downsize or disappear thus causing increased vacancies and 2) due to the soft market many tenants have requested rent reductions from their landlord to help keep them in business and landlords have voluntarily granted them as it is most often in their best interest.


This situation leaves many commercial property owners in the tenuous situation of having to”feed the property” or support the monthly loan obligations while the property cannot sustain itself. At some point many owners have to determine if it is worth trying to hang on to their properties. The question that is often asked is do I want to keep spending good money after bad in this particular investment.


The lenders on the flip side are having no choice but to send out default notices if the payments due are past 30 days. If the lender feels that deficiencies are not curable and that the property is not being managed properly many will initiate some kind of foreclosure action and attempt to take the property back or at the very least appoint a receiver.


The good news in this scenario is that commercial lenders are realizing that it is often in their best interest not to aggressively pursue a foreclosure action. Often a better action is to modify on a temporary basis the terms of the note. Sometimes this can be done with the shortfall being forgiven by the lender. Some lenders are under such heavy regulatory pressure that the best solution is simply to move the note off their books through a short sale or short refinance. This can often be done where the lender will realize more than would come from a foreclosure. One key component in determining the best course of action for both lender and borrower is an accurate measure of the current value of the property. This is not an easy task where many of the comparables typically used in a valuation or appraisal are a balance between foreclosure sales and legitimate investor income or capitalization rate based sales. This value becomes a moving target. This is also one reason why appraisal firms are so busy. Values are changing monthly and have a wide range of variance.


If a short refinance is pursued as a course of action since the traditional commercial finance markets are so tight the best alternative is often private financing. This adds a whole new dimension of complexity to the process. Borrowers may even have to give up future equity to accomplish this short refinance with a private lender.


The other significant question that bears weight in the decision of what to do is the level of personal guarantees associated with the particular property. In many commercial properties, ownership involves multiple partners and this further complicates the situation. If some of the partners are not able to make necessary cash calls you can imagine the stress that is created.


Many borrowers would be well advised to get professional help in trying to make these difficult decisions, as there is usually significant equity at risk. Find someone that you feel will take the time to get familiar with the details of your commercial property. Also take the time to find someone that will understand the different values that your property will have in this distressed market. Finally, find a professional that will not be too pushy or adversarial with your lender as they are not obligated to do what the borrower desires to accomplish. Remember we are working for the most part in uncharted waters for both borrower and lender and no one knows how long these distressed market conditions will continue.