Commercial Executive Magazine
BY RODRIC J. BRADFORD
Experts discuss the process, rights and benefits of placing a property into receivership
An increasing number of commercial real estate professionals are looking to court appointed receivers to help maintain the integrity and value of a property that is heading toward foreclosure. Just a few years ago the terms “Receiver” and “Receivership” were nearly unheard of in the real estate industry. Today these terms are used daily and are synonymous with a welcome solution to problematic properties.
Court-appointed receivers are responsible for protecting each individual property for all parties involved during the pending litigation—which is most often a foreclosure action. Once the court places possession and control of a commercial property with a receiver, the receiver acts as an officer of the court and must comply with the court order. The court order outlines the rights, duties and responsibilities of the receiver. Receiverships protect the lender from physical and environmental liabilities, protect tenants by making sure that property services continue as well as handle maintenance issues that could become a detriment to the property throughout the foreclosure process.
Recently, Commercial Executive Magazine held an exclusive “Receivership” roundtable to discuss the changing real estate marketplace and the need for court appointed receivers in today’s volatile commercial real estate industry. Craig Hannay, the President of 25-year old, Phoenix-based Hannay Realty Advisors, was the key sponsor and Moderator of the roundtable. The other participants included five professionals that each play major roles in the receivership process. Among them were brokers, attorneys, loan managers and commercial real estate asset managers. The discussion was focused on the following points: the importance of court appointed receivers, how their role is changing with today’s changing real estate environment and what they foresee for the industry in the near future.
CH: Court-appointed receivers are being used with much greater frequency in this cycle than in previous downturns. What do you attribute this to?
JP: Compared with earlier recessions, many more loans this time are nonrecourse. Defaulted borrowers in many cases have nothing to lose by walking away from properties or failing to manage them properly. Quickly getting a Receiver in place can stop a slide in property operations.
RB: The real estate market has become much more expansive and international in scale than during previous economic downturns. Lenders and special servicers often are located thousands of miles away from the properties that serve as collateral for their loans. As a result, having a reputable Receiver with local market knowledge is helpful to resolve these cases.
AK: Control of property cash ow is often seen as a bargaining chip by borrowers. Getting a Receiver in place takes this off the table. Also, analysis of our results since the wave started in 2008 has shown us that loss severities are reduced by quickly moving to take control of defaulted commercial real estate loans either directly or through a Receiver.
JC: In addition, clauses in loan documents that allow for the appointment of a Receiver have become more common, and the statutes in some states (including Arizona) have made the process of getting a Receiver appointed simpler.
CH: What are the primary reasons a lender or special servicer request that a Receiver be appointed to take over control of a property?
AK: One important reason is to get control of property cash flow. In addition, leasing activity, both new and renewal, is often at a standstill when a borrower is in default on their loan. This could be a result of the borrower having insufficient cash to be able to carry out the capital requirements necessitated by the leases. It could also be indicative of the borrower simply throwing in the towel and not being actively engaged with the property any more. There may, for example, be a major lease that could be executed on a property securing a defaulted loan, but the lender is unwilling to advance or release funds without a Receiver in control.
CH: We have seen cases where the rental rates necessary for the property to operate above a break-even level were significantly above current market lease rates. In some of these cases the borrower was unable or unwilling to sign new leases or renew existing leases at current market rates because the borrower wouldn’t see any direct benefit. It is almost always better to have a property leased, even at today’s lower rates, than to have the property vacant. Having an independent court-appointed Receiver in place enables leasing activity to continue at the property.
JC: Foreclosing on commercial real estate without having copies of leases, plans, keys, computer records, utility contracts, etc. can be a very painful experience. The court order appointing a Receiver requires the borrower to turn over all documents and records relating to the property to the receiver. This helps ensure a smooth transition and continuity of operations.
RB: The financial strain that the borrower is under usually goes hand-in-hand with reduced service levels at the property. Tenant relations are often poor or worse by the time the borrower goes into default, and capital repairs may also be overdue. The Receiver’s ability to take over and do what is best for the property not only stabilizes the situation but it turns the property in a positive direction.
CH: Are there any other reasons for implementing the receivership process?
JC: If the lender doesn’t want to take title to the property through foreclosure, the Receiver can sell the property directly with court approval. This is particularly useful in cases where there may be environmental liability at the property and the lender doesn’t want to take title.
AK: CMBS debt can be assumed by a new buyer/borrower prior to foreclosure. However, once the property has been foreclosed on, the debt is extinguished and the buyer of the property must purchase with cash or obtain their own financing. By offering an assumable CMBS loan through a receivership sale, the property can sometimes sell for more than if it were sold for cash by the lender after foreclosure.
CT: We have seen as much as a 15 to 25% increase in price for an asset with assumable CMBS debt compared with a cash price.
RB: With the significant work load that most loan managers have these days,
some lenders are advocating receivership sales simply as a way of streamlining the process of dealing with problem assets. If the Receiver sells the property to the highest bidder and that sale is approved through the court, the lender or servicer has one fewer property to foreclose on and deal with.
CH: Are Receivers used with the same frequency regardless of the type of loan – CMBS debt, bank loans and agency loans?
RB: Of the 75 cases we’ve handled in the last two years, about two-thirds have been CMBS debt, with the balance being traditional bank debt.
AK: The special servicers of CMBS debt deal in such large volume and on a nationwide level that we are accustomed to and are very comfortable with the receivership process.
CH: Explain the distinction between guarantees of bank debt and guarantees of CMBS debt.
JC: Traditionally, most bank debt is limited recourse to the borrower and often full recourse as to an individual guarantor or guarantors under a bank loan guaranty. If the bank takes a loss on a loan the guarantor is liable for those losses.
JP: The personal guarantee on most CMBS debt is limited to certain items called carve-outs. The most common items in CMBS guarantees are environmental liability, fraud or misappropriation of funds, and bankruptcy. The mere existence of a loss by the lender doesn’t usually trigger personal liability on the part of a guarantor.
AK: So if the borrower files bankruptcy with CMBS debt, a personal guarantee usually kicks in. This provides a heavy disincentive for the borrower to file bankruptcy in most cases.
JC: The threat of bankruptcy ling by the borrower with traditional bank debt can be a factor as well due to the existence of personal guarantees on those loans.
CH: What is the process for having a Receiver appointed?
JP: The attorney for the lender files a motion with the court asking that a Receiver be appointed due to the existence of a default under the loan. The process and time frames vary somewhat among the different states, but in Arizona the process is quick.
JC: Even non-emergency cases are typically heard within a couple of weeks.
RB: Once the court approves the appointment of a Receiver, the Receiver typically has to post a bond with the court.
CH: Once a Receiver is appointed, do operations change? Does it affect tenants? What happens to leasing?
RB: The goal with the receivership process is always continuity, especially with multifamily properties. The hope is that property operations are stabilized and actually improved. Our independence as Receivers puts us in a unique position to make sure that the property is well served.
JC: The court-issued receivership orders are broad enough to give the Receiver authority to properly manage and maintain the property and make all operational decisions so that there is limited interruption of tenants’ use of the property.
CH: What we find when we take over property is that the flood gates open with calls from the tenants. The property has often fallen into disrepair so there are frequently maintenance issues. Tenant complaints are common. As it pertains to leasing, tenants frequently tell us that prior to the appointment of the Receiver they have had difficulty negotiating with the borrower or even getting a response from the borrower with regard to lease renewals. As a result, leasing activity often explodes when we take over a property.
AK: The Receiver typically appoints a property manager and leasing agent, which may or may not require the lender’s approval. Our hope is that tenants are not affected at all, and in fact they are frequently pleased with the increased level of service provided by the Receiver and their property manager, relative to that which was being provided by the defaulted borrower. Leasing typically improves once a Receiver is in place as lenders become more willing to advance funds for tenant improvement and lease commission costs.
CH: Last year Arizona courts affirmed the right of Receivers to sell a property without going through foreclosure first Has this ruling caused an increase in the number of receivership sales?
RB: We have conducted a number of receivership sales in the last year. With the process being relatively streamlined and as it becomes more known, we believe that the number of receivership sales will continue to grow. Having said that, the majority of properties securing defaulted loans will continue to go through the traditional foreclosure process.
AK: Given Arizona’s relatively rapid (90 day) foreclosure period, the ruling has not led to a large increase in receiver sales at CW Capital. However, I can certainly see the value of this ruling in certain cases, particularly if the lender does not wish to take Title, either because they wish to sell immediately or because of environmental or engineering issues.
CT: While the ability to offer assumable CMBS debt can increase the sales price of the property, we have found that portion of the receivership sale to be extremely time-consuming and complex. The assumption of CMBS debt often takes months, to the point that the completion of the loan assumption is holding up the rest of the transaction.
CH: Chris, as a broker how has your role changed with the increased use of Receivers?
CT: There definitely has been a role change for me as a broker with the increased use of Receivers. It is common for Receivers to obtain very little information on the property. As brokers we are used to having significant amounts of due diligence information to provide to prospective buyers, and with so many of these lender cases, we are dealing with a limited amount of property information. There are also more “layers” in the transaction before the process can be executed: having to work with counsel, reporting with the Receiver and working with the client before everyone knows their roles. The sale process has for us become significantly more process heavy and complex.
CH: How much longer do you expect the foreclosure crisis to continue?
AK: There are a couple of different factors here. First, the maturity default wave is defiantly going to continue as large volumes of 5-year debt from the 06/07 vintage comes due. While capital markets have opened up, particularly in core coastal markets, valuations have not recovered anywhere near enough to refinance these loans at par. The 5-year maturity wave will then be followed up in 2014 by 10-year maturities from 2004 onward, when CMBS really took off. It remains to be seen if we will see a sufficient recovery in valuations to allow these loans to be refinanced. It should be said of course that maturity default does not necessarily mean foreclosure. A lot of maturity extensions are being done provided that the borrowers are willing to put some new money at risk.
With regard to Arizona, I think the problem is the sheer volume of defaulted commercial real estate loans across all loan types, which is keeping rents suppressed. I find that most people (myself included), believe in the long term positive demographic, growth, employment story here in Phoenix, but the volume of defaults and foreclosures makes it very hard to point to serious rent growth in the next few years, and rents have fallen a very long way from their 2007 highs, particularly on retail properties. This makes it very difficult to claim that many of the loans originated at the height of the market will be able to secure refinancing when they come due.
Finally, we are seeing an increasing divide when it comes to property types. Hospitality has bounced back. Multifamily is considered the hottest sector right now in terms of transaction activity and valuations. This is primarily driven by the sector’s ability to access GSA debt, but also by its perception has a less volatile asset class. Retail and office properties continue to underperform.
RB: With vacancy rates so high and leasing demand so soft, particularly in office and retail properties, I don’t see the end in sight.
CH: One of the few positives I can see is that the recent trend in assets coming through our door has been toward large properties and higher quality assets. During the RTC days of the early 1990s, the large, higher quality assets went through foreclosure late in the cycle. I am hopeful that the same rule will apply this time. I don’t think we are done with the wave of defaults yet, but perhaps there is a ray of sunshine on the horizon. Arizona is still a very attractive place to live and work compared with much of the country, and that will ultimately help us grow out of the mess we are currently in.