Consider Long-Term Consequences Before Renegotiating Mortgage
If you're struggling, you may be considering renegotiating your mortgage. Although mortgage renegotiation may temporarily help your cash flow problem, be aware that it may not be a permanent fix.
The risk involved—and the amount of leverage you have—in renegotiating will depend largely on the type of commercial property loan you have: recourse or nonrecourse. Before entering into a mortgage renegotiation, it is critical to understand your loan and how a mortgage renegotiation will affect not only you, but also your obligations to your tenants under their leases.
Prepare Before Approaching Lender
Before asking your lender about renegotiating your mortgage, get a complete command of your current financial situation. You can't use generalities or simply announce that you are not making as much as you used to. And you need a complete understanding of current competitive and comparable properties—in other words, the local market. The value of your property is tied to lease rates. If your neighbors are able to charge lower rent, that's an important factor to know. You should also have a complete understanding of the loan documents and the lender's rights and remedies.
It is also crucial to consider your exposure to personal liability under the guarantee of the debt and any “bad boy” carve-outs. In other words, the lender will have different—and more detrimental—remedies against you if you have personally guaranteed the loan instead of using the property as collateral.
If you personally guaranteed the debt, you have a recourse loan. Your lender is not limited to just the remedy of repossessing the property if you fail to pay. It can come after you for the deficiency because you personally guaranteed the debt.
“When you are in that situation—and plenty of borrowers are because many loans require a personal guarantor—the lender has the most leverage,” says Steven D. Sallen, president and chief executive officer at Southfield, Mich.-based law firm Maddin, Hauser, Wartell, Roth and Heller, P.C.
“It's one thing to walk away from your investment in a property, but it is another thing entirely to have a lender sue you personally for a large loan,” he stresses. With a recourse loan, you stand to lose the building as well as personal things, like cash, retirement and brokerage accounts, cars, or vacation homes, he warns.
A nonrecourse loan gives you a much greater ability to renegotiate because the mortgaged property is the sole collateral for the security of the loan. And most nonrecourse loan borrowers are single-purpose entities, like a limited liability company, whose only asset is that property. If the loan goes into default, the lender's only viable remedy may be to foreclose on the mortgage and take possession of the property.
A borrower with a collectible guarantee, however, is in a far weaker negotiating position because it can't just walk away. “With a nonrecourse loan, it is over when the borrower says it's over,” emphasizes Sallen, who specializes in real estate, corporate, and environmental law. “But in a recourse loan, it's not over until the lender says it's over,” he adds.
Practical Pointer: Even nonrecourse loans can become partially and sometimes even fully recourse loans when owners engage in certain bad acts like stealing insurance proceeds or pocketing security deposits and leaving town. Bad boy carve-outs give the lender more remedies against you if you do these or other illegal things.
No Renegotiation Without Default
Keep in mind that mortgage renegotiation is a high-stakes game because it will affect you and your tenants. Lenders will not renegotiate anything with owners unless or until they default on their loans, says Sallen. You can't have it both ways by asking your lender for help while you are still making payments. You can't simply call your lender and say that things are tough and you want to renegotiate your loan, advises Sallen.
There are so many defaulted commercial property loans that lenders can't keep up with the volume of the problem, so the only owners that are getting attention are those who stop making payments.
“An owner that is going to choose to renegotiate its mortgage first has to mentally accept the decision—because there is no turning back,” says Sallen. As soon as you default, your lender will send a default notice and then accelerate the balance of your loan. Once that happens, you can't necessarily return to the status quo. After a lender accelerates the balance of a loan, it's too late.
“Be prepared to go into a mortgage renegotiation fully, or don't go into it at all,” warns Sallen. And know that you will be negotiating with people other than those with whom you had your loan relationship. A special assets department of the bank or special servicers will represent the lender. Their purpose is not to solve your problem. Rather, it is to maximize the value of the loan's collateral and return it to their client, your lender.
You may think that your lender is being unreasonable and also nonsensical by taking back property that it is just going to hold onto, just because the borrower has missed some payments. “What's going on in the market right now makes no sense,” Sallen observes. “Lenders may be ill-equipped to operate the properties that they are taking back, but are doing it anyway,” he notes.
Renegotiate in Light of Current, Future Leases
It is also critical to consider how a mortgage renegotiation will affect your tenants and the obligations you have to them. Owners need to be mindful of ongoing lease obligations, says Sallen. For example, an owner may be obligated to build tenant improvements for a recently signed lease. However, the lender may prohibit the diversion of rents to that purpose. So approval of such arrangements needs to be requested in advance.
Also, troubled owners may have difficulty borrowing funds for new tenant buildouts. You have to anticipate having sufficient operating funds to pay for tenant improvements and leasing commissions for new leases and renewals.
“If cash flow is insufficient to support these future needs, the loan modification must anticipate and structure reserves sufficient to support these needs,” says Sallen. “Without the cash necessary to support tenant improvement and leasing commission obligations, the project will eventually fail,” he points out.
Be Realistic
Sallen has been seeing trouble delayed rather than prevented altogether. “People have a misconception about what it means to renegotiate or modify a mortgage,” he says.
Owners that renegotiate are probably getting short-term cash flow relief, but at the end of the day, little or none of the debt is being forgiven. It is probably being deferred instead. The point of mortgage renegotiation is to help cash flow for a foreseeable period of time. If things improve by the end of the renewed loan term, it may work out for the lender and owner. But if there inevitably is going to be a loss, the renegotiation will have only delayed it by a year or two, not stopped it. Sooner or later, someone is going to end up taking a loss.
Understand that mortgage renegotiation can cause serious ramifications for owners and their tenants. “Ultimately, there is no panacea here today,” notes Sallen. “Today, the mood among lenders is not welcoming: They don't want you to ask for help; they will not be happy to modify your loan,” he says.
If there is no other way to save its investment, the lender may minimize its loss by accommodating you in such a way that it can maximize the value of the loan's collateral, hoping that the economy will come back and it won't be hurt too badly, he adds. Of course, owners hope that they will not be hurt that badly, either.
Practical Pointer: Remember that, depending on state and federal tax law, there are some serious tax ramifications for owners that are entering into a mortgage renegotiation, loan modification, or short sale, or giving property back to the lender. Consult a tax professional to find out how you could be affected.
Insider Source
Steven D. Sallen, Esq.: President and Chief Executive Officer, Maddin, Hauser, Wartell, Roth and Heller, P.C., 28400 Northwestern Hwy., 3rd Fl., Southfield, MI 48034-1839; (248) 354-4030; sds@maddinhauser.com.
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