The second half of 2023 and the first part of 2024 included moderation from the Federal Reserve Board with respect to interest rates. The effects of the interest rate run-up continue to be felt, however. Recent moderation in rates and indications that rates may be lowered in the near future have boosted activity in many markets, although values remain flat. Office building markets, in many areas in particular, continue to be plagued by rent shrinkage, lower occupancies and mortgage defaults caused by the expiration of long-time lower interest rate mortgages.
In a recent transaction, a major New York office building owner purchased non-recourse debt on one of its buildings for less than $.10 on the dollar. I’ve been involved in other transactions that may trade at about that level of discount. Those deals are bringing new investors as office buildings need to be renovated and tenant improvements and brokerage commissions for new leasing activity need to be advanced. In addition to the interest rate leveling off, optimism has been created because of the steady office absorption rate even with leasing rates and rents at lower than pre-pandemic levels.
In one recent transaction, a new office tenant signed a lease for several floors that had been abandoned by a large co-working company, accompanied by an investment by the tenant in the landlord entity, and a modification and extension of the building’s mortgage – a potential win-win for all three parties. Although the landlord in this building took a hit on valuation in the sale of the interest in the landlord entity, by stabilizing the occupancy and the mortgage, the landlord created an attractive building for other tenants. Creative deals like this create survivors in a tough market.
Other segments of the industry including self-storage, biotech and data farms are taking advantage of the moderating values and are attracting investors. Opportunity funds have proliferated and capital is available for workouts and note purchases although, in mortgage foreclosure jurisdictions, court calendars remain slow due to pandemic backlogs.
While hotels still trade below pre-pandemic levels hotels, they have been helped by the end of the pandemic with “Revpar” increasing and many municipalities cracking down on short-term rentals such as Airbnb.
With lenders willing to take significant discounts to the amounts owed on mortgages, investors are circling assets but strategizing about the groundwork needed to get a distressed property to a place where a new investor can rescue the property; this is crucial but is also time-consuming.
Five Steps for Owners and Brokers to Speed Deal Closing
First, make sure all the paperwork for the property’s mortgage and ownership is together and easily accessible by lawyers, accountants, and, when needed, title companies. This may be a harder task than expected due to changes in property managers, the death or disability of the owner’s principals, lawyers or prior brokers, and assignments of the mortgage to a new lender. Be methodical. Make sure all amendments to the documents are located and analyzed. Who owns what? Who has died? What consents are needed for leases, new investors, etc.? Early involvement by competent counsel who knows commercial mortgages and ownership structures and is familiar with the local litigation and bankruptcy courts is key. If there are claims that a lender acted improperly, be sure to gather all facts and correspondence and make sure the individuals involved are prepared to describe the facts.
Second, don’t be afraid of bankruptcy court. Bankruptcy laws are designed to help businesses fairly resolve their debts and get a fresh start. Alternatively, a bankruptcy court auction is often a good way to quickly get to a sale of the key asset with a third-party investor serving as a stalking horse bidder prepared in advance to offer a fair price.
Third, don’t defraud anyone. While each situation has its own circumstances that counsel will need to evaluate, it is crucial not to intentionally mislead lenders and investors. You may not have a duty to speak, but if you speak it should be truthful. Attempts to mislead expose owners, counsel and brokers to future claims and those lies wind up being discovered in the end. Be transparent about current cash flow and how it’s being used.
Fourth, get to know the rental and sale market well. Perhaps the most important item in preparing projections for new investors is the rental values for the property and the timing and costs associated with obtaining those values. Nothing defeats a workout proposal quicker than a gross over or underestimate of future rentals values. You lose credibility very quickly. Investors often have seen other pitches with other rents being obtained and will not be fooled. If you are not familiar with the rental market, hire a broker who is.
Retain a team early on. There are brokers and consultants who know various segments of the market and lawyers who are better at these matters than others. Beware of conflicts – not only actual conflicts but political conflicts. Don’t hire a broker who makes his or her living as a mortgage broker representing lenders. Don’t hire a lawyer who mostly represents lenders even if he or she doesn’t represent the lender involved – they may be hesitant to push the envelope. In many jurisdictions, this is a difficult task given the status of lenders in town.
Lenders want to resolve and move on from legacy default issues. New investors are looking for opportunities. Owners, brokers and counsel should be prepared to work together to achieve results such that all sides live to fight another day.
