Outcomes and Lessons:

A Mortgage Restructure Primer – 2011’s Most Improbable Case

It’s not often that one engagement can highlight so many lessons. Following is one such story; the names and details have been changed to maintain confidentiality. In April 2011 CMS was engaged to explore a mortgage refinance for a TIC-owned office building in a second tier metropolitan market. The property was fully leased with a strong Fortune 500 client for the next four years. There was a first and a second mortgage on the facility, both maturing in 90 days. The first position loan was a CMBS loan for $65MM. The second loan was a $20MM portfolio loan from a financial institution. Finally, ownership was a 30-member TIC that had purchased the property in 2006.

Refinancing Initiative:

1. Due to the quality of the tenant, several refinancing offers were received, each predicated on a lease extension
2. The offers all included shortfalls that would need to be funded by ownership or other means ranging from $3MM – $5MM, and would subsequently have provided $10MM – $20MM in future distributions to owners over the 10-year period
3. The TIC Steering Committee entered into discussions directly with the tenant’s leasing broker
4. The tenant proposed a 10-year extension to the current lease
5. The tenant’s leasing broker would be paid a $3MM fee under this proposal, which would be paid by the TIC
6. The Steering Committee refused to pay the $3MM leasing fee
7. The leasing discussions went on for 75 days beyond the mortgage maturity with no conclusion
8. Meanwhile, the TIC began paying default interest of $350,000 per month
9. Both lenders were considering foreclosure
10. Refinancing offers could not be solidified due to the lack of a lease extension
11. The TIC was using up its remaining resources that would be needed to obtain the refinancing
12. The need for shortfall funding, combined with the tenant leasing fee, exceeded the resources available to the TIC

Structured Equity Solution:

1. In early August, the Steering Committee informed CMS that it was going to sell the property. Ownership was using up its resources and did not have the willingness to fund future cash calls, nor the capability to fund the shortfall that would be necessary for a refinance of the property
2. The best offer the TIC received was for $75MM
3. In September, CMS obtained a purchase offer from a REIT for $90MM, in which the REIT would:
   1. Pay default interest costs going forward
   2. Insulate the TIC members from any cash calls / infusions going forward
   3. Convert present ownership to a new entity that would:
      1. Maintain the tax deferred status of owner-ship; this deferred taxes on over $50MM of basis by TIC members
      2. Allow ownership to continue to participate in property performance going forward
   4. The REIT then:
      1. Finalized an attractive lease extension with the tenant
      2. Secured a $60MM low interest mortgage
      3. Put $30MM of equity into the project
4. The second note holder reduced its loan payoff by 10% of the outstanding principal, increasing proceeds to owners
5. The second note holder also agreed to not charge the TIC interest once the LOI had been signed by the TIC
6. The transaction closed in less than 75 days

Lessons:

1. TIC ownership structures are not designed for rapid decision-making
2. As a result, TICs must work harder to remain competitive and poised for changing business conditions
3. At least quarterly, members should meet to review and determine the following:
   1. Most recent 12-month trailing financial result
   2. Most recent 24-month forecast
   3. Confirmation of ownership objectives and capabilities
4. Make plans to deal with mortgage maturity at least 12 months before it occurs – too often, the maturity date is overlooked
5. Third-party assistance
   1. Property Management firms can provide valuable assistance in marketing, pricing, and updating financial projection
   2. Ownership will need to determine its capabilities in analysis of resources and confirmation of ownership objectives
   3. Firms for which mortgage restructure is their core business will provide the best alternative for discussions with the lender
6. Exit strategy and back-up exit strategy(s)
   1. Base your exit strategy on your projected revenue streams, not property appreciation that is what the financial marketplace and sophisticated investors rely upon
   2. Confirm your exit strategy quarterly: ownership objectives change
7. TICs and Partnerships
   1. In today’s CRE marketplace, anything less than structured quarterly meetings to discuss the above is a recipe for unpreparedness and potential failure
   2. Today’s specialized marketplace requires the
      capability to deal with special servicers, lenders, financing organizations, appraisers, and brokers to provide comprehensive and longterm solutions for their properties