Since 2022, we’ve seen 12 historic rises in interest rates. That’s a massive strain on anyone’s business plan. Additionally, we’ve witnessed an explosion in insurance costs. Many of you who have leverage—a loan with a lender—have faced certain insurance requirements imposed by the lender for the property. Seeing these insurance costs rise exponentially, sometimes by 73% or even over 100% in certain markets or submarkets, is, again, a strain and stress that some properties simply can’t bear.
Hey, welcome back. I’m Dugan Kelley with Kelley Clarke. Whenever we’re talking about loan restructuring or modification, I like to remind clients—whether you’re a buyer, seller, sponsor, operator, or syndicator—that you’re a steward first and foremost. You’re entrusted with other people’s money or the property as a whole. So, stewardship is about the careful and responsible management of something entrusted to one’s care.
When considering yourself as owning a piece of property for the benefit of other people, many of whom are passive investors, you’re truly a steward. So, when pondering whether your deal is in distress, ask why it’s in distress and what the best form of stewardship might be.
Reasons Warranting a Loan Modification
In recent months and the past year, we’ve witnessed a tremendous swing in market volatility in commercial real estate. Several key indicators contribute to this volatility. One major factor is the historic rise in interest rates. Since 2022, there have been almost 12 such historic increases, massively impacting any business plan, regardless of the asset type and especially if there’s a loan involved.
Furthermore, there’s been a significant surge in insurance costs. Many leveraging properties with loans are subject to lender-imposed insurance requirements, witnessing these costs soar by 73% or even over 100% in certain markets or submarkets. This strain becomes unbearable for some properties.
Moreover, utilities have seen increases of over 40% in some markets and submarkets. Additionally, there’s the issue of maturing rate caps. For instance, if you have a floating rate or bridge loan where the lender allowed a rate cap for only two years of a three-year loan, acquiring a new rate cap now could lead to substantial disparities in premiums compared to those at the property’s purchase in 2019.
These factors, among others, contribute to the market volatility and might necessitate a potential re-modification for your deal.
FDIC Encouragement to Lenders to Collaborate with Creditworthy Borrowers
In late June 2023, the Fed, FDIC, and other regulators issued joint guidance for borrowers, sponsors, operators, syndicators, and both bridge and agency lenders. They encouraged lenders to work prudently and constructively with creditworthy borrowers to potentially modify or restructure existing loans. This guidance emphasizes treating the loans as performing, aiming not to penalize lenders modifying loans to support otherwise creditworthy borrowers navigating market volatility.
If you suspect your deal might be in distress, it likely is. It’s time to consider approaching your lender and engaging in dialogue about potential restructuring or modification.
Winston Churchill once said, “However beautiful the strategy, you should occasionally look at the results.” Results matter. Your strategy for approaching your lender for a loan modification must be realistic and appropriate for your property, considering the lender’s position as well.
Areas of Possible Modification to Discuss
Let’s explore possible areas of modification. These could involve fixed-rate versus floating-rate adjustments, reconsideration of interest rates, modifications to rate caps, evaluating reserves held by the lender (such as capital expenditure or interest reserves) that could potentially be applied towards loan repayment, discussing the debt service coverage ratio (DSCR), and reviewing maturity dates and associated fees.
Thank you for joining us. Stay tuned for part 2 of loan modification releasing in February 2024.
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