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July 24, 2023 Expert’s Corner

Commercial real estate loans are coming due — what lenders, property owners, tenants and managers need to know

Brion J. Kirsch

Commercial real estate loan portfolios are facing a tidal wave of maturities at a time when certain commercial real estate classes are potentially entering a crisis.

Countless properties were purchased and/or refinanced at a time when interest rates were historically low, and occupancy levels and operating expenses were stable and predictable.

All of this has changed.

Loans secured principally by office and retail properties could see values drop by as much as 40%, with vacancy rates skyrocketing to levels of 20% or more.

While these properties may have performed well enough to cover debt service and operating costs in recent years, because of bank failures, structured buyouts, rising geopolitical tensions, historic inflation, rapidly increasing interest rates and lower occupancy levels, the pressure is mounting on commercial property owners and their lenders.

Sales of commercial mortgage-backed securities (CMBS) fell about 80% in the first quarter of 2023 as compared to 2022, according to Bloomberg, which also projects that $1.5 trillion of U.S. commercial real estate debt will mature and become due and payable by the end of 2025.

Owners, tenants, property managers and lenders need to understand the current climate and take steps now, before it is too late, to address the issues that will arise when a commercial loan goes into default.

Resolve the problem before it becomes a problem

A lender should conduct a thorough review of its file, the loan and the collateral.

If the default is not cured, or the parties are unable to restructure the loan, the lender faces the options of foreclosing on the property, taking a deed in lieu of foreclosure or exercising other remedies that may be available.

If an owner of a troubled property sees a potential default, or an inability to refinance the existing indebtedness secured by the property, the owner should approach the lender as early as possible to start the discussion about restructuring and extending the loan.

The options that should be exhausted before resorting to litigation include selling the property, raising capital or simply turning over the keys to the lender.

If those options don’t work and the owner wants to keep the property, the loan can be restructured through reorganization in a bankruptcy proceeding.

Litigating the foreclosure action, if bankruptcy is not an option for the owner, becomes the next best option.

Rights are not uniform

Residential tenants have certain rights provided by state statutes, but commercial tenants don’t have the same safeguards.

They should determine if they have the ability to remain a tenant in the property post-foreclosure, what happens to any security deposits, and whether agreements made with the owner will be honored by the foreclosing lender.

The rights, duties and obligations of the parties — the borrower, tenant and lender — need to be well-thought-out and documented prior to foreclosure.

These issues, including those regarding attornment, non-disturbance and subordination, are all significant legal concepts that affect everyone involved. Commercial tenants must understand their significance and address them before it is too late.

Otherwise, they could become collateral damage.

Like tenants, property managers must also take stock of their contractual rights and responsibilities. If the property manager has not entered into an agreement with the lender, the lender may have the option of removing the property manager at the onset of the foreclosure process.

If the property manager has no contractual relationship with the lender, it should take steps to establish one and negotiate for certain rights. One such circumstance would be to remain the property manager following the initiation of a foreclosure.

Set guidelines for how and when monthly income will be collected and distributed, as well as the fees that the property manager can charge and collect.

When commercial properties fail, it creates a downward spiral of economic contraction in the form of job losses and vacant properties.

The domino effect is felt by everyone in the community, including the banks that serve those communities.

There’s still time for action, but the first steps must be taken now.

Brion J. Kirsch is co-chair of the real estate department at law firm Pullman & Comley LLC.

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