When Banks Become Landlords: Lenders Prepare for the Commercial Real Estate Crash

Book: The Commercial Real Estate Tsunami: A Survival Guide for Lenders, Owners, Buyers, and Brokers Author: Tony Wood (Foreword by Matthew Anderson) ISBN: 978-0-470-63637-4 Chapter 6: Lenders Prepare for Impact

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Remember the three monkeys? See no evil, hear no evil, speak no evil? Tony Wood opens Chapter 6 by basically saying that is the commercial lending industry’s entire strategy. Except they gave it a fancier name: “extend and pretend.”

And honestly? That is a wild way to handle trillions of dollars in loans.

Banks That Cannot Handle the Truth

Here is a story from the chapter that made my jaw drop. Tony’s business partner Gordon Stevenson had a loan come due in 2009. The guy had perfect credit. Huge net worth. He put 50 percent down on the property. Never missed a single payment. Had been a customer at this bank for years.

All he asked for was a temporary extension until he could find new financing. Pretty reasonable, right?

The bank went straight to threatening foreclosure. In 20-point font emails. The electronic version of screaming at someone. It took nine months of meetings, more threatening emails, and hiring an attorney before the bank finally agreed to what Gordon asked for from day one. A simple extension.

That bank later got slapped with a cease and desist order from the FDIC. Shocker.

And this is one of Tony’s big points. If banks would just deal with problems honestly and early, everyone would come out better. But so many lenders were stuck in denial mode, refusing to acknowledge that their loan portfolios were in trouble.

The “Loan Workout Specialist” Problem

Here is something I did not know before reading this chapter. Some banks took their own loan officers, the same people who approved all these bad loans, and turned them into “loan workout specialists” overnight.

Think about that for a second. The person who approved the risky loan is now in charge of figuring out what to do when it goes bad. The conflicts are pretty obvious.

Tony describes conversations that went like this:

Borrower: “The condos are not selling. There are no prospects.”

Workout Specialist: “Can you make a payment next month?”

Complete disconnect. The borrower is waving a red flag, and the loan officer just pretends everything is fine. Like a doctor who responds to “I think my leg is broken” with “But can you wiggle your toes?”

How Lenders Should Actually Handle This

Tony lays out a pretty clear plan for what lenders should be doing instead. And it starts with one simple step: acknowledge the problem.

Stop relying on outdated appraisals. Stop pretending the property is worth what it was three years ago. Get honest assessments from commercial real estate brokers who actually know the local market. Use broker price opinions instead of just appraisals, because appraisals look backward by design. In a falling market, that backward view is basically useless.

Then comes the harder part. Lenders need to accept that they are about to become property owners whether they like it or not. And when that happens, they need to act like actual property owners. That means:

• Getting real property management in place
• Keeping tenants happy so they do not leave
• Maintaining the buildings so they do not fall apart
• Selling properties the way a normal seller would, not through weird internal processes that scare off buyers

Tony shares a case where a lender got a great offer on a property but insisted on negotiating with a lower first offer instead. The first deal fell through. Luckily the second buyer was still interested. But that kind of stubborn process costs banks millions.

The Eric Von Berg Interview

This chapter features a long interview with Eric Von Berg, a big name in commercial mortgage banking. And he drops some serious knowledge.

The core issue according to Eric: the entire commercial lending system got rebuilt around securitization (CMBS). Then the residential subprime crisis killed securitization. Without that funding source, there was no way to refinance the mountain of commercial loans coming due.

Eric makes an interesting point about apartments versus everything else. Because Fannie Mae and Freddie Mac backed apartment loans, those values held up much better. But office buildings, retail, industrial? All getting hammered. Properties with “hair on the deal” (meaning any kind of problem) had to sell for all-cash prices because nobody could get financing.

The really scary part? Cash buyers at that time wanted to double their money in five years. That is how cheap they expected to buy.

Eric also explains how a cottage industry of note buyers was popping up. These guys would buy troubled loan bundles at 30 cents on the dollar, then offer the borrower a 30 percent reduction to refinance. Everyone wins except the bank, which left a ton of money on the table. All because regulations prevented banks from offering the same discount directly to borrowers.

Special Servicers and CMBS Workouts

The chapter includes a really useful breakdown of how CMBS loan modifications work. Here are the key points that stood out to me:

Can CMBS loans be modified? Yes, but only after the loan gets transferred to a Special Servicer, which usually happens after 90 days of missed payments.

What motivates the Special Servicer? Money, basically. They get servicing fees plus 100 percent of default interest and modification fees. They also get a 1 percent disposition fee on foreclosure. So they are not exactly neutral parties.

Should you try to negotiate with a Special Servicer on your own? No. Get a mortgage banker and attorney who know the CMBS world. The Special Servicer does not care about what is best for you. They care about what maximizes returns for bondholders. Period.

And here is a detail that made me laugh: one of the listed motivations for Special Servicers is “civility.” As in, if you are a jerk, you become a target for foreclosure. Be polite. You have basically no bargaining power anyway.

The Legal Side of Loan Workouts

The chapter ends with a deep section from attorney Maura O’Connor about how loan workouts actually work from the lender’s side. I will spare you the full legal breakdown, but here are the highlights:

Lenders have a lot of power when a borrower defaults. They can foreclose, go after other assets, pursue guarantors. But foreclosure is expensive, especially if the borrower fights it or files for bankruptcy.

So most lenders would rather do a workout than foreclose. But they will only negotiate if they think the borrower is being honest and adding real value. Lenders make quick “good or bad” judgments about borrowers, and if you end up in the “bad” pile, good luck getting a workout deal.

One thing that surprised me: loan documents from the boom years often have serious errors. Wrong legal descriptions, typos in names, missing exhibits. Maura says it is shocking how many foreclosures get complicated because nobody bothered to proof the paperwork when the loan was originally made. She had one case where the legal description of the property was so wrong that they needed a litigator and months of court proceedings just to sort it out.

My Take

This chapter is basically a wake-up call for the banking industry. And reading it now, you can see that many of the problems Tony identified are structural ones that did not go away just because the immediate crisis passed.

Banks are not set up to be property owners. They do not want to be property owners. But when a wave of defaults hits, that is exactly what they become. And the ones that refuse to adapt, that keep playing the “extend and pretend” game, end up losing the most money for everyone.

The most useful advice in this chapter comes down to one thing: deal with reality early. Get honest valuations. Bring in outside experts. Treat the workout process like a business negotiation, not a punishment. And for the love of everything, hire a lawyer who will actually proof the loan documents.

This is part of a series covering “The Commercial Real Estate Tsunami” by Tony Wood. The book was published in 2010 by John Wiley & Sons.