The commercial real estate industry is facing an impending tsunami of $2 trillion in debt maturities, with an estimated $929 billion coming due this year . If you will be caught in this net because the loan secured by your CRE asset is approaching maturity, it is likely that you are also facing prevailing market interest rates that are nearly twice the rate under your loan. It is also possible that the estimated fair market value of your CRE asset is substantially less than the outstanding principal balance of the loan. The available cash flow from the asset also may have declined resulting in your deferral of needed repairs, replacements and capital expenditures.

Given these challenges and today’s continuing unfavorable market conditions, your lender may be unlikely to adopt an “extend and pretend” approach for your maturing loan . It may, however, be willing to consider a sound loan restructure proposal if, despite the decreased value of the CRE asset and its reduced cash flow, you address the lender’s interests in recovering the amount loaned and include a plan for stabilizing the asset so that the lender can recover some or all of the value of its collateral. Your proposal will also need to include lender favorable terms that compensate it for taking the risk of sticking with you rather than just “throwing in the towel” and either exercising remedies or selling the loan at a discount. Many lenders are taking this approach. Current projections indicate that CRE loan modifications in 2024 will expand beyond the record completed last year.

Develop a Business Case. How should you prepare for a loan restructuring transaction? The first step is to develop a detailed business plan to reposition your asset. What combination of loan term modifications, mortgage pay downs, cash infusions into the property and other tactics will help stabilize your CRE asset going forward? What modified loan structure will offer the lender (and you) the greatest assurances that you will not default under the loan going forward? The goal is to demonstrate that your proposed loan modifications and lender concessions can ultimately support the lender's long-term recovery of its investment. This analysis is intrinsically tied to the specific circumstances surrounding your asset. It may also be dependent on whether you have or can identify a source of additional capital to be infused into the property or used to “right size” the loan.

Sample Loan Modification Terms. What modifications to your loan will best position you to reposition your asset and improve the chances that you will avoid a default under your loan? Here are some examples of terms that you might include in your business plan:

• Note “A” and Note “B”. Consider splitting the outstanding loan amount into two separate notes. Note “A” might align with the asset’s current market value and available cash flow for debt service. Note “B” would evidence the remaining principal loan balance. Note “A” might require regular debt service payments, representing the “performing” portion of the loan. Note “B” might only require contingent payments based on the property achieving certain financial benchmarks or upon the future sale or refinancing of the property. If Note “B” is not sooner repaid, the lender might agree to waive it completely when you repay Note “A” on its maturity date, assuming you don’t otherwise default under the modified loan.
• Interest Rate Adjustments. You can also propose different interest rates for Note “A” and Note B”. Note “A” can reflect a stated interest rate that is market-based but only require a lower “pay rate” on a current basis. The “stated” but unpaid interest can accrue until the maturity date (or waived by the lender if Note “A” is otherwise fully repaid). This approach may enable you to improve the asset’s cash flow, assist in stabilizing the asset and facilitate the timely payment of the required debt service. A higher market-based rate can be required for Note “B” to compensate the lender for the “pay rate” on Note “A” and for accepting the increased risks associated with its agreement to restructure the loan.
• Maturity Date Extension. Maturity date extensions should be pursued for both notes. The maturity date for Note “A” can align with the projected cash flows from your asset and anticipated future refinancing opportunities. Note “B” can have a similar maturity date or one that possibly coincides with a balloon payment at the time of refinancing or sale of the asset. In all cases, try to get sufficient time (with, if possible, several extension rights) so that you can stabilize the asset, complete required repairs, and capitalize on potential market improvements.
• Modified Payment Terms. For Note “A”, as an alternative (or in addition) to a lower interest “pay rate”, consider revising the amortization schedule to lengthen the amortization period and reduce your monthly payments or converting a portion of the debt to interest-only payments for a specified period. For Note “B”, you can also propose interest-only payments, with the option of accruing and capitalizing interest into the principal loan amount until a stated trigger event occurs (like a property sale or refinancing). Reducing monthly debt service payments may allow cash flow to be directed towards needed repairs and capital expenditures for your asset.
• Forbearance Agreement. To ensure that you have sufficient time to reposition the asset once the modified loan is in place, request a forbearance agreement from the lender. This would require the lender to agree to refrain from exercising its remedies for a meaningful period after the loan is modified – including its remedies of loan acceleration, foreclosure and possibly the appointment of a receiver. Additionally, if sufficient available cash flow to service the loan is a challenge, consider a temporary forbearance agreement that would delay (and accrue) all loan payments until the property’s financial performance is reasonably projected to improve.

What Are you Giving the Lender in Return? Your loan modification proposal will have little chance of success unless it is accompanied by new terms offering more protections and benefits to your lender in return for its willingness to work with you. These might include one or more of the following terms:

• Covenants and Guarantees: Offer additional covenants or guarantees to further secure the loan, which may include additional personal or corporate guarantors or a pledge of additional collateral (such as cash flow from other assets). The scope of the existing guarantees might be expanded to include debt service payment guarantees or additional non-recourse carveouts guarantees such as for losses incurred by the lender if you challenge the enforceability of the loan documents or the right of the lender to exercise its remedies if you default under the modified loan. Additional loan covenants might include an agreement to make a lump sum partial pay down of the loan or an infusion of additional cash into the property, such as to complete needed repairs or deferred capital expenditures.
• Profit Sharing or Equity Kicker: Consider offering your lender a share in the property's equity appreciation or profit upon sale, beyond the principal and interest repayments and above a certain threshold of sales proceeds. This concession can be used as a bargaining chip for the lender’s agreement to a lower “pay rate” on Note “A” or to compensate the lender if Note “B” is later forgiven for the lender’s loss of a portion of the principal repayment of the loan. If regulatory constraints limit the terms or amounts of the debt restructuring, an equity participation could be used as a creative solution that does not violate regulatory thresholds or capital requirements for lenders.
• Reserve Accounts: Offer to create or replenish reserve accounts for capital expenditures, repairs, and replacements, giving the lender assurances that the asset will be maintained and improved.
• Prepayment Penalties: Consider offering prepayment penalties on Note “A” to ensure that the lender receives retains a beneficial interest rate for a predetermined period, potentially waiving these penalties for Note “B” based on its subordinated risk position.
• Professional Management: If necessary, offer to engage an alternative professional management team to oversee the property's operation if the lender believes this would optimize its performance and value. Your willingness to consider changes in property management can be reassuring to the lender since it could lead to improved operations and increases income.

Use a Collaborative Approach. It's important to approach discussions with your lender with a collaborative mindset. The lender has an interest in avoiding default or foreclosure, which could be costly and time-consuming. A carefully crafted loan restructuring proposal should present a sound business plan, including needed loan modifications and lender concessions, that shows the potential for the asset's improved performance and a reasonable path for the lender to recover its investment and be made whole.

[View source.]