The commercial real estate market has
experienced sharp decline in recent
months and foreclosures and bankruptcies are on the rise. Local bankruptcy and
insolvency attorney James C. Bastian Jr. says
that the problem is only going to get worse.
Many owners of commercial real estate are
struggling as businesses close and tenants
depart, leaving those owners short on cash
flow and unable to pay on their loans to the
bank.
“What happens when you have a commercial property that’s in distress is the natural friction between the lender’s rights and
the idea of preserving the perceived equity
in the property,” says Bastian, a partner at
Shulman Hodges & Bastian LLP. “Those
forces come into conflict, and you’ve got
the lender on one hand trying to collect on
its debt and you’ve got the owner trying to
stay in control and stave off the lender.”
Smart Business spoke with Bastian
about how to survive in a down market by
taking a hard look at your tenant mix and
by reaching out to your banker.
When your commercial property falls into
distress, what are your options?
If you have a property that was fully
leased, but then a couple of tenants go out
of business or go bankrupt, you’re stuck
with a property that’s not fully occupied.
Your cash flow suffers and you’re going to
fall behind on your debt. You need to sit
down with your lender, explain the situation and adjust your cash flow models. Be
realistic with the lenders and say, ‘This is
what we can do.’
It is not uncommon when a piece of commercial property falls into distress to see
the lender seek the appointment of a receiver to take control. That’s something that’s
involuntary, keeps the owner out of control
and really is for the benefit of the lender.
You need to attempt to work out a negotiation with the lender and say, ‘We understand we’re in default, we know it’s bad, but
we don’t want a receivership, we don’t want
a bankruptcy. We want to enter into a settlement with you and have you forebear, or
modify, the terms of the loan to allow us to
stay in control.’
In exchange, you have to offer a great deal
of financial disclosure and reporting, and
you probably will have to agree that the
rents get put into a lockbox that will be controlled by the bank and used to operate on a
tight budget and also to pay the debt down.
How important is an open relationship with
your bank?
If the relationship between borrower and
lender is broken down, it creates a lot of
problems. You have to have dialogue. But
from the borrower’s perspective, that dialogue is often one-sided, where the lender is
making demands and restrictions that are
not palatable. To level the playing field,
bankruptcy lurks as an arrow in the quiver
of the borrower. The foreclosure remedy,
the receivership remedy, those are the big
hammers for lenders.
Both sides know what they have at their
disposal and, ideally, that leads to some
constructive settlements and saves money
and preserves the project. If you don’t have
dialogue with the lender and ignore or deny
their requests, they’ll lower the boom. But if
you are upfront and you engage them right
away, a deal can often be worked out.
How can working with your banker keep you
out of foreclosure or bankruptcy?
You meet in the middle, and you try to
come up with a deal that’s better and cheaper for everybody. Depending on how flexible the lender is willing to be will drive how
this plays out. If the lender flexes its muscle
and tries to pursue its remedies, the only
real option for the company with the real
estate is to file bankruptcy. If you provide
good information and maintain an open dialogue, and both sides are realistic, a deal
should be feasible.
What steps can you take to avoid getting into
trouble?
You have to be very careful in watching
your tenant mix. You don’t want to be concentrated in industries that are potentially
going to fail. The retail sector is going to be
tough. They lose money, they close the
store and they vacate.
You’ve got to stay ahead of that, make
sure you’re not too heavily concentrated in
one area and find tenants who have long-term staying power, who aren’t dependent
on cyclical areas of the market. If it’s something that’s the new hot thing, you have to
be very careful.
Make sure those who rent from you are
capable of paying the terms of the lease,
even if their business fails. You often have
to get personal guaranties and standby letters of credit — especially with businesses
that are new or not very well capitalized.
By having so many onerous demands, you
can scare people away. But if you don’t
have high standards for your tenants, you
can get left holding the bag.
You have to be flexible and offer concessions. It’s far better to keep a tenant at a
lower rate than to cling to that higher rate.
Landlords could go to their tenants and
say, ‘Will you extend for five years if I lower
your rent by 20 percent?’ Then they have a
longer-term commitment, they’ve got a
cash flow projection they can count on,
and they stabilize their property for a
longer term.
JAMES C. BASTIAN JR. is a partner at Shulman Hodges & Bastian LLP. Reach him at (949) 340-3400 or [email protected].
