Inquiring minds might be wondering what they should do if they are struggling in a commercial real estate deal. Here’s a question along with an answer from my “California Business Banker” friend.

“Struggling In Atlanta” writes:

Hello Mish,

We purchased a small commercial building in Atlanta in late 2007 for $1.3 million. In an attempt to be prudent, we put 30% down and opted for a fixed rate mortgage. We got a 7.25% rate by entering into a separate interest rate swap with the bank tied to Libor.

In 2008, our major tenant went bankrupt but we were able to replace them 3 months later with a new tenant. However, the new lease rate was about 30% below what we had from the previous tenant. Since then, we have added new tenants and are almost at the prior income level, but we still are not making a profit.

Here’s my question: Do banks have any incentive to come back to the table with us and renegotiate our loan before we start making late payments?

We can keep up, but only by contributing some savings. I know the banks don’t want to be landlords but what is the best way to approach this with our bank?

Thanks for any assistance.
Struggling In Atlanta

Hello SIA, I have no practical experience in these situation but my commercial banker friend does. I bounced your email off “California Banker” who replied …

Hi Mish

In regards to your friend in Atlanta with the commercial real estate investment that has turned over. The first thing they should understand is they are not alone. Finally, commercial real estate has caught up with the residential market, and I see a lot of people who have the very same issues. I actually have a client going through this issue with another bank.

There are three things I would encourage them to understand or research:

1) Virtually all commercial real estate loans are not reported to personal credit agencies, so it’s highly likely a delinquent commercial real estate won’t impact their personal credit.

2) They should review their loan documents to see if they signed as guarantors, which essentially puts their personal net worth on the hook. Given the interest rate swap loan, they might not have, which would be good, but the answer impacts their strategy.

3) Lastly, they should check their documents for a prepayment penalty which is very standard on fixed rate loan. And given the swap type loan I would guess they have the Yield Maintenance type which is typically an eye popping penalty.

Step one in their plan: Take their loan docs, their tax returns, and personal financial statement, and see an attorney that specializes in real estate, “NOW”. Far too many people wait until the end of the process, when it’s to late.

Step two, “The Bank”: I haven’t heard of too many banks looking to help someone while they are current on loan payments. It’s the community banks that seemed to be more proactive when a problem arises. So, after a visit with the attorney and his blessing, go talk to your banker and lay out the issues. Chances are their banker will pass the info to people higher up at the bank who can actually make a decision. It’s important to understand that their loan officer or relationship manager is probably not the person who makes the decision and often they have no idea what the bank will really do. So, you might get various answers over time, and it will be frustrating.

I’m going to share something about the banking industry many people just don’t understand: Before a loan goes into foreclosure there are 3 stages of delinquency. They are 30-89 days late, 90+ days, and loans on non accrual (loans with no viable way to make payments). As loan moves into later and later categories, banks are forced to set aside more money for expected losses. That money comes right off the profit and loss statement, which most bank executives hate. So, if they let the payment go late 30-60 days they still might not get the bank to the table. After 90 days you should get their attention.

So, if you talk to the bank on the first go around and they are willing to play ball, that’s great. However, if you don’t get the answer you want in 60 days, it’s probably time to let the payment go late. I do not like the idea of burning savings to keep it afloat, so I wouldn’t give the bank a lot of time, as they hope you will keep making payments.

Step 3: Letting the payment go. This part of the process you want to keep your attorney involved in. It might be able to deed the property over to the bank, or do a short sale, and you’ll want your attorney to review any paperwork involved. If however, the bank is willing to play ball at this point, I would request an interest only loan structure for 12 months. That should turn your building cash flow positive for 12 months, and you can rebuild your savings. Also, during the process of letting the payment go, save all the rent and build cash.

My personally opinion is that the commercial real estate market will get worse over the next few years, so getting out of the investment entirely is my preferred strategy. However, every deal is different. One size does not fit all.

Again, see an attorney first, and also share this data to make sure it works for your situation.

California Business Banker

The most important step in the process is the first one. Please do as “California Banker” suggests. Take your loan docs, tax returns, and personal financial statements, and see an attorney that specializes in commercial real estate law, “NOW”.

What neither California Banker nor I know is your personal finance situation, how long you can hold out with negative cash flow, your job status, etc. You need to discuss all of that with someone who knows the laws for your state.

Good Luck.

Mike “Mish” Shedlock
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