More and more borrowers are handing over the keys to their distressed buildings, according to panelists at the IMN Distressed CRE West Forum in San Francisco this week, leaving their lenders with no court fight to foreclose but often a “pretty messy” clean up job filled with potential pitfalls and liabilities.
About one-third of distressed borrowers recently have been offering a deed-in-lieu of foreclosure to their lenders, according to Dan Duarte, director of the special assets department at Chico-based Tri-Counties Bank, who moderated a panel on “Forced Owner Exit Strategies.”
Duarte said it had been years since he had seen this many borrowers ready to walk, oftentimes leaving the bank with not just the building, but also past due taxes.
(Photos by Emily Landes)
(Photos by Emily Landes)
(Photos by Emily Landes)
(Photos by Emily Landes)
(Photos by Emily Landes)
“The borrower is actually coming to the bank and saying, ‘Look, will you accept a deed-in-lieu? We’re done. We don’t want to go through the foreclosure process. We don’t want to take on default interest rates. We just want to hand it back to you,’” he said.
But banks do not want to own more buildings, especially where the value of the property becomes significantly lower than the debt. So while there is some simplicity to deed-in-lieu agreements, “we spend a lot of time trying to avoid that,” said Seth Moldoff, director of special assets for Umpqua Bank.
“The offer of the deed-in-lieu is interesting, but it’s usually not going to work out well from the bank’s perspective,” he said.
Moldoff added that sometimes his frontline bankers will try to put a property that’s up to date on payments into the workout group just because they are a few years behind on property taxes. But in the current environment, that’s not enough to make the grade, he said.
“I understand the concern, but we’ve got to focus on the companies that aren’t making the payments to the bank, and we’ll deal with the property taxes at the end of the day,” he said.
Taxes and other liabilities, like payouts to vendors that lag the deed-in-lieu, can make them “pretty messy,” said Sandra Adam, director of financial diligence and forensic analysis at SitusAMC, even if there’s a creative solution where a loan sale occurs before the foreclosure.
“Working out who gets what and when could take months,” she said. “There’s multiple things going on in the background and at the same time the vendors need to get paid, so cash needs to be distributed.”
Some lenders have also been loath to part with reserves to help pay off debts, even before a loan is in default, and that’s a “big no-no” that could lead to a lender liability suit, according to Thad Wilson, partner at law firm King & Spaulding.
“If you’re telling borrowers, you really have got to fund this out of your capital, out of your own pocket, you may think that’s a wise decision today, but I can assure you that if the loan goes into default you will regret that decision down the road,” he said.
The distress conference was the second for real estate conference company IMN on the West Coast and attracted about 220 ticketholders, many of whom came in from out of town, according to organizers. As such, most panelists spoke to more general market conditions that were not specific to the Bay Area.
At the same time, it’s “no coincidence” that the conference was held in San Francisco, also for the second year, according to Heather Turner, CEO and founder of Portland-based Tamarack Capital Partners, a hospitality-focused investment firm. Turner called San Francisco a “great long-term market” where her company has done over $1.5 billion in hotel deals over the years, but also one with a lot of distress, and therefore a lot of opportunity for buyers with patient money, like family offices.
“When we look at markets like Portland and San Francisco that have had very poor recovery relative to pre-COVID levels. Those are prime buying opportunities for longer duration capital,” she said. “It’s probably early still, in my opinion, in some of these markets for private equity funds who are looking for a three- to five-year flip because there’s still a little bit too much uncertainty in order to achieve the types of returns that they’re looking for in those time horizons.”
Echoing comments made by those in the earlier panel, Turner said her company did a “very cooperative” deed-in-lieu on a hotel property with a lender because “we’re not going to put good capital after bad and end up with a basis that we’re never going to get that new money out of anyway.” That gave Tamarack the ability to deploy those funds into more opportunistic deals instead and left the firm’s relationship with the bank “on equal footing” to where it was before the deed-in-lieu, she said.
Relationships and transparency between borrowers and lenders are key when things get tough — a refrain from many panelists throughout the day. For Bay Area investors, the transition from a white-glove local bank like Silicon Valley Bank or First Republic to a big national bank like JPMorgan has been “one of the most unenjoyable experiences in the history of mankind,” according to Riaz Taplin, founder and CEO of Oakland-based multifamily developer Riaz Capital.
“Making sure that you have a lender that you can talk to if you’re in the value-add developer business, as opposed to a lender that will not fundamentally talk to you is the biggest decision to make at the front end,” he said. “Will I ever need to talk to this person? If the answer is yes, make sure that your relationship with them is as important to them as it is to you.”
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