It’s just commercial real estate financing.  How hard could it be?

I recently read a case study on commercial real estate financing involving a pretty complicated debt stack and can see some possible places to penetrate the stack for some good deals.  Fixing the financing in a real estate deal can be either the easiest way to make a profit or the most difficult way, even more difficult than extensive rehabs and renovations, if you don’t have a thorough understanding of the numbers.  The moral to this story is to not bite off more than you can chew, especially when it comes to financing, and to leave your emotions at the door.  Sometimes even seasoned professionals just can’t ignore their egos and buy something that doesn’t make any sense.  Their loss can be our gain, though, as long as our math is better than their math.

How can we look into the mathematics behind commercial real estate financing?

In a previous post, I mentioned that the mortgage lender typically will not allow junior liens to be attached to the same piece of real estate that secures the mortgage loan because of complications that could arise if the property owner/mortgage debtor declares bankruptcy.  This is no longer the exception in commercial real estate financing, but is now the rule.

In typical commercial real estate debt structures now, such as what is shown here, the mortgage lender has the strongest rights to the property in the event that a foreclosure action has to be pursued or even if the borrower has to declare bankruptcy since there are no junior liens attached to the real estate.  Commercial mortgage loan borrowers declaring bankruptcy used to be relatively infrequent but nowadays it seems like you’re unusual if you haven’t gone bankrupt at least once so this is a debt structure that was created out of necessity by mortgage lenders to best protect their interests.  Anyone holding equity positions at the top of the stack are the most at risk of losing in this structure.  Let’s see how this often plays out in real life and if good deals can be structured from this kind of commercial real estate financing.

In April 2007, NJ-based Lightstone Group LLC borrowed $7.4 billion to buy the 680-hotel chain Extended Stay Inc. from New York City-based Blackstone Group LP.  The mortgage lender had a $4.1 billion stake in the game while the remaining $3.3 billion needed to make this purchase was borrowed in 10 different layers of mezzanine loans.  As is typical with this financing arrangement, the only lender with a lien on the property was Wachovia Bank.  All the subordinate lenders were mezzanine lenders that held claims to the mezzanine borrowers’ interests as collateral.

In commercial real estate deals with multiple lenders, there are usually intercreditor agreements between each lender and lender(s) in subordinate positions to protect all of their interests, one of the key features of these agreements being that a foreclosing lender must give subordinate lenders the chance to bring the loan current rather than just be able to complete the foreclosure and wipe out all subordinate lenders.  This might allow us to slide into some deals by purchasing one of the mezzanine lenders’ interests or by purchasing a mezzanine debtor’s position in the deal.

In the Extended Stay case, Lightstone purchased the hotel chain at too high of a price for anyone to do anything other than wipe out almost $5 billion of debt before the numbers made sense for anyone to take on the risk of picking up the pieces of that mess.  This means that all mezzanine debt was wiped clean from the deal and even the mortgage lender had to take a loss to shed this non-performing asset.  Extended Stay emerged from bankruptcy in October 2010 with a new owner, Centerbridge Partners, LP and a lot less debt.  Because there was only one mortgage lien attached to the property, the mezzanine lenders were left only with ownership interests in worthless entities.

The debt structure of the Extended Stay deal was more complex than most.  There are many potentially good deals with only a mortgage lender or maybe an additional mezzanine lender on board for the ride.  In any case, it is possible to buy out the position of one of the mezzanine lenders or borrowers to step into their place subject to the mortgage lender remaining in place.  It is important to have a competent attorney review the intercreditor agreements, though, to make sure that this won’t trigger a mandatory loan payoff.  Buying out a mezzanine debtor’s position is similar to buying single-family houses “subject to” the other lien holders remaining in place.  Similarly, if the math works, you can buy the asset at a higher loan-to-value than if you were to bring in completely new financing to pay off all existing loans.

Of course, it does no good to try to buy out mezzanine positions if the foreclosure on a property is complete since mezzanine positions have been wiped clean from the property by then, so a few distressed properties on my list that have not yet gone to auction as of this writing include:

Property Name	Asset Class	Location	Reason For Distress	Est. 1st Mortgage Balance
Meadowchase	Apt	10751 Meadowglen LnHouston, TX	Owner/GP Bankrupt; Transferred to Special Servicer	$10 Million
Santa Fe Square	Retail	925-1115 South Gilbert RdMesa, AZ	Delinquent/Default	$23.6 Million
Mansions North	Apt	5113 North Brookline AveOklahoma City, OK	Transferred to Special Servicer	$2.8 Million
Regency Lodge	Hotel	909 S 107th AveOmaha, NE	Delinquent/Default	$6 Million
Forest Park Apts	Apt	580 Dewdrop CirCincinnati, OH	Maturing Loan; Transferred to Special Servicer	$12.5 Million
Parkside Village	Apt	10701 Pecos StDenver, CO	Delinquent/Default	$12.8 Million
1459-1461 Vfw Pkwy	Apt	1459-1461 Vfw PkwyBoston, MA	Delinquent/Default; Receivership, Admin, Special	$8.2 Million
5168 Yarmouth Ave	Apt	5168 Yarmouth AveEncino, CA	Delinquent/Default	$3.9 Million
Sonoma Coast	Apt	180 Canyon DrOceanside, CA	Delinquent/Default	$11.9 Million

While not all of the potential deals on my sheet have mezzanine lenders involved, I’d be willing to bet that many of them do.  If you can step into an existing mezzanine position by either replacing a borrower or buying the note, this will require much less up-front capital and allow you to enter the deal at a relatively high investment-to-value. 

Just make sure that any commercial real estate financing that you step into doesn’t turn into quicksand.

Here are a few related sites that may give you more information relevant to your needs. Thanks for visiting Aesir Group commercial finance.


Some Real Estate Loans That Lost All Their Value and More ...
Yahoo! Real Estate - Homes for Sale Houses for Sale & Real Estate
BBA Real Estate Finance Major @ SMU Cox
Twitter / @Remodel_Rules/finance-real estate-legal
Industries at a Glance: Financial Activities
Holding company | Define Holding company at Dictionary.com


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