Commercial Property Owners in Trouble: Learning to Swim with the Sharks
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 7: Owners and Borrowers Learn to Swim with the Sharks
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If Chapter 6 was about how lenders need to get their act together, Chapter 7 flips the script. Now Tony Wood is talking directly to the people who own commercial buildings and owe money on them. And the message is pretty blunt: the rules changed, and if you do not change with them, you are going to lose everything.
The Math Is Not in Your Favor
Here is the situation Tony lays out. If you got a commercial loan between 2004 and 2006, the average loan-to-value ratio was about 70 percent. Meaning you put 30 percent down. Sounds reasonable.
But then values dropped. A lot. Vacancy rates went up. Rental rates went down. Cap rates increased, pushing values even lower. Add all that up and your 30 percent equity cushion is gone. Maybe the building is now worth less than what you owe.
So what do you do? Tony says you basically have three options:
- Come up with more cash to refinance at the new, lower values
- Negotiate a loan modification or workout with your lender
- Walk away and let the bank take the property through foreclosure
For big REITs and partnerships with deep pockets, option one might work. For the average commercial property owner? Not so much. And that is the fundamental problem this chapter addresses.
Take Care of Your Building (Seriously)
Before getting into the legal stuff, Tony makes a really practical point that I think a lot of people overlook. Take care of your property.
During the boom, property management was almost an afterthought. If a tenant left, no big deal. Another one was right behind them, probably willing to pay more. If the building needed work, whatever, values kept going up anyway.
Those days are over. Tony says owners need to treat every tenant like gold. When a tenant asks for a rent reduction, do not just say no and hope they stay. Actually look at their business. Check their financials. See if they are viable. Because losing a tenant in this market means:
- Lost rental income for months or years (vacancies last longer now)
- Paying for new tenant improvements
- Brokerage commissions to find a replacement
- A weaker building that is harder to finance
A fair rent reduction is almost always cheaper than dealing with a vacancy. That is just math.
And Tony makes another good point: even if you have a property management company, you need to be watching them closely. The management company is learning the new rules right along with you. Nobody has dealt with this kind of market before at this scale. So stay involved. Review every service contract. Get competitive bids. Do not just assume someone else has it handled.
Loan Workouts and Modifications
This is the meat of the chapter. If you are underwater on your commercial loan, Tony says the first thing to do is assemble a team:
Commercial real estate brokers. Interview two or three. You need someone who knows your specific market and property type. They will help you figure out what your building is actually worth right now, not what it was worth three years ago.
Legal counsel. Not just any lawyer. Someone who has experience with commercial loan workouts. They need to understand the contracts you signed and where you might have flexibility.
Mortgage bankers. Especially for CMBS loans, you need someone who speaks the language of special servicers.
Tony points out a frustrating catch-22 that many borrowers face. Lenders often will not even talk to you about modifying a loan unless you are already in default. It is like telling your doctor you feel sick and being told to come back when you are dying. The system is set up to react to fires, not prevent them.
Some borrowers were even advised to miss payments on purpose just to get their lender’s attention. Which is terrible advice because it destroys your credit. But it shows how broken the system was.
The Maura O’Connor Interview (Part Two)
Tony brings back Maura O’Connor from Seyfarth Shaw LLP for another in-depth interview. And she does not hold back.
On CMBS loans, Maura explains something important. The “Special Servicer” who handles troubled CMBS loans has the authority to modify them. But authority and willingness are two different things. The Special Servicer answers to different classes of investors, each with different interests. The lowest-risk investors want to get paid back fast. The highest-risk investors might benefit from a longer workout. The person who actually gets to call the shots is whoever holds the “first loss” position and is still “in the money.”
It sounds complicated because it is. This is not like negotiating with your local bank. There are layers of investors and legal agreements between you and any kind of deal.
Maura also makes a sharp observation about the economy. She compares the commercial real estate crisis to the S&L crisis of the 1990s, which took five or six years to work through. Some people got wiped out. Others toughened up and became better operators.
But here is the part that really stuck with me. She argues that falling commercial real estate values might actually have a silver lining for the broader economy. When real estate costs drop, it becomes cheaper to do business. Companies can afford more space. New businesses can get started without being crushed by rent. A high-cost state like California could become more competitive.
That is a cold comfort if you are the one losing your building, obviously. But it is an interesting perspective.
The Bailout Problem
Maura’s views on government bailouts are pretty strong. Her basic argument: the government transferred losses from irresponsible lenders and borrowers to taxpayers. Privatized gains, socialized losses. And the longer that strategy continues, the more damage it does.
Her concern is that “pretend and extend” policies prevent real price discovery. Nobody knows what anything is actually worth because sellers will not sell at real prices and buyers will not pay fake prices. That stagnation freezes the whole market.
She is not against the initial emergency bailouts to prevent panic. But she argues the government needed to change strategy once the markets stabilized. Let the bad deals fail. Let prices find their real level. Yes, it hurts. But dragging it out hurts more.
Whether you agree with that view or not, it is hard to argue with the logic. Markets cannot heal until prices reflect reality.
What Borrowers Should (and Should Not) Do
The chapter ends with practical advice for borrowers facing a workout. Here are the key points:
Do your homework first. Understand your property’s value, your cash flow, and your legal position before you approach your lender. Too many borrowers show up unprepared and make the wrong ask.
Hire fresh legal counsel. Do not rely on the lawyer who did your original deal. Fresh eyes catch things. Maura says about one out of every two or three loan documents from 2005 to 2007 has at least one major documentation problem. Wrong legal descriptions. Bad guaranty waivers. Incomplete note transfers. These flaws can give you bargaining power.
Be honest and cooperative. This comes up again and again. Lenders will work with borrowers who are straight with them. Lie, hide information, or go silent? You are getting foreclosed on.
Do not let the property fall apart. Even if you are in trouble financially, keep maintaining the building. Many loans have “bad boy” clauses that make the borrower personally liable if they let the property waste away. Shutting off utilities or skipping maintenance can turn a non-recourse loan into a full recourse nightmare.
Consider all options. Sometimes the best move is to give the property back. It is painful, but bleeding cash on a hopeless project will not save it. The sooner you stop the bleeding, the more of your other assets you keep. Selling one project to save the rest might be the smart play.
Do not be a jerk about it. Maura lists six things to avoid in a workout: lying, going silent, asking without analyzing your position, waiting too long, making the other side do your work, and being rude. That last one is not just manners. It is strategy. Difficult borrowers get pushed to the bottom of the pile.
My Take
This chapter is packed with practical advice, and it holds up well years after publication. The fundamental lesson is simple: face reality early, build a team, and negotiate from a position of knowledge rather than desperation.
What strikes me most is how much of this comes down to basic human behavior. People avoid bad news. They hope problems will fix themselves. They wait until the last minute to ask for help. And in a market downturn, that instinct to delay is the most expensive mistake you can make.
The tenant management advice is also worth highlighting. Whether we are in a boom or a bust, treating tenants well and running a tight operation is just good business. It is easy to get lazy when times are good. But the owners who stay disciplined are the ones who survive when things go sideways.
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.