Commercial real estate distress has stopped being a headline about someone else’s portfolio. For owners, sponsors, operators, guarantors, and investors, it is now a set of decisions that have to be made this quarter: what to say to the lender, what to sign, what to sell, and how much personal exposure is already on the table.
In a recent webinar, Dugan Kelley, Managing Shareholder of Kelley Clarke PC, broke down what is actually driving this market cycle and what borrowers can do about it before their options narrow. The full session is below. The summary that follows captures the framework we use with clients every day.
The 2026 Maturity Wall Is Driving This Cycle
Roughly $875 billion in commercial and multifamily mortgages mature in 2026 — about 17% of all outstanding CRE debt. That wall is the single largest market factor behind the distress we are seeing.
The deals feeling it most closed between 2019 and 2023 on floating-rate bridge debt: two- to three-year interest-only terms with testing attached to any extension, underwritten on the assumption that a permanent Freddie Mac, Fannie Mae, or HUD takeout would be waiting. Then the Federal Reserve raised rates further and faster than at any comparable point in modern history. Rate cap premiums skyrocketed, insurance costs in some markets quadrupled, and new supply built through COVID came online and softened rents. None of that had anything to do with the sponsor’s conduct — and all of it broke capital stacks that otherwise worked.
It also changed where deals trade. Lenders are now steering buyers to sellers directly, moving assets off-market before foreclosure. This is not a broker-centric market — if your only deal flow comes from commercial brokers, you are seeing a fraction of what is actually moving.
This Is a Valuation Problem, Not a Cash Problem
Understanding the lender’s position is what makes a workout possible. Brokers who move foreclosed product will tell you a foreclosed asset is often worth roughly 50% less than the face of the debt. That is the single most useful fact a borrower can carry into a lender conversation.
Most lenders are not loan-to-own. They are institutions caught in the same cycle, holding paper worth more performing than repossessed. When your lender is effectively your largest investor, a foreclosure is a loss event for them too. That shared pain point is the foundation of every successful restructure.
You Can Pay Every Dollar You Owe and Still Be in Default
A monetary default is easy to understand: you owed the payment and came up short. Non-monetary defaults are the ones nobody explains at closing, and they are where most sponsors get caught.
The most common trigger is the debt service coverage ratio. A rate reset pushes DSCR below the required threshold and the covenant trips, even though every payment was made on time. From there the sequence is predictable:
- Covenant trip. The rate reset forces DSCR below the required floor.
- Cash management. Funds move into a deposit account control agreement or hard cash management. Discretion over your own operating account is gone.
- Operating cash choke. Property-level liquidity and working capital evaporate.
- Accounts payable surge. Payroll, maintenance, property management, contractors, and marketing all back up.
- Liens. Unpaid vendors file, and lien claims create their own recourse exposure.
What many general partners did next was quietly write personal checks — unsecured member loans to keep the stack upright while hoping the market turned. That instinct comes from caring about the deal and the investors. It also has a finite runway, and the honest question is how many months of it are left.
The Myth of Non-Recourse Debt
Most bridge and agency debt is conditionally non-recourse: it stays non-recourse until you do something that converts it. Those conversion events are the bad boy carve-outs in your guaranty, and because guarantors are typically joint and several, another control party’s bad act can land on you.
The recurring ones are worth reading against your own property:
- Bankruptcy. A voluntary filing — or an uncontested involuntary petition — is often full recourse the moment it happens. It is a thermonuclear option, not a reset button.
- Fraud or misrepresentation. Give the lender the reporting it asks for, when it asks for it, and make sure it is accurate.
- Misappropriation. Rents, insurance proceeds, and escrows go to the property and the debt. Nowhere else.
- Waste. Deferred maintenance and physical deterioration — a favorite lender theory when a value-add plan stalls.
- Unauthorized transfers or subordinate debt. New capital, dilution, follow-on offerings, and ownership restructurings without lender consent.
- SPE violations. Commingled books, the entity doing anything other than owning this asset, personal expenses run through the property.
- Letting insurance lapse. The property is the lender’s only security; a catastrophic uninsured loss is the fastest route to a full-recourse claim.
Two points cut the other way. First, agency carve-out language is public — Freddie, Fannie, and HUD documents are online and bridge lenders largely track them, so you can read exactly what you signed. Second, a lender who forecloses, repositions, and then cannot resell has made its own business decision; that miscalculation does not by itself create a deficiency claim. Carve-out claims are also defensible. Waste allegations in particular often fall apart when a borrower can show the shortfall came from objective market conditions rather than neglect — but that defense depends on a record built as events unfold and a lender educated over time, not on a story assembled after the lawsuit arrives.
Pre-Litigation Discipline: The Work You Do Before the Notice of Default
Negotiating with your lender without having read your own loan documents is like settling a lawsuit without reading the complaint. Before any substantive conversation, three things need to happen.
Audit and identify. Locate every notice and cure timeline for non-monetary defaults. Confirm whether you actually have a DSCR violation. Map your cash management and waterfall triggers so you know what happens if account access disappears. Verify special purpose entity compliance.
Control the message. Do not ghost your lender, your investors, your property manager, or your vendors. Silence is itself a communication, and it is the one that escalates discontent into litigation. Consistency is what closes workouts: deals that looked hopeless have closed because the messaging never wavered, and deals that looked easy have failed because multiple general partners freelanced and told different groups different things. Never volunteer a breach you have not yet committed, and loop counsel in before written responses and demand letters go out, not after.
Deploy property-level tools. Partial pay arrangements, negotiated rate cap extensions, and proactive management of vendor payables to neutralize lien threats. Small liens matter more than sponsors expect: in some states a $1,200 lien holder can move to foreclose on a $30 million property, which is why an uncontested lien makes a lender nervous.
The Alignment Problem Most Sponsors Miss
In a distressed environment, your third-party property manager’s interests and yours are not aligned. They are compensated on gross revenue collected, they prioritize their own people and vendor relationships, and payables generally get paid before debt service. You signed the guaranty; they did not. That gap is why sponsors start looking at vertical integration around 1,500 to 2,000 doors.
The same question applies inside your cap stack. Most operating agreements give the control party authority to make the hard calls, including the decision to sell — and selling for a modest profit beats a foreclosure. Friction comes from making that call without educating the other general partners, the limited partners, and the vendors first. Lawsuits that clear, consistent updates would have prevented are the most expensive kind.
A Workout Is a Menu, Not a Single Tool
There is no single restructure. There is a menu, and the right combination depends on your property, your documents, and your lender:
- Loan modifications and extensions
- A/B note splits that create a space for new capital to come in with lender consent
- Discounted payoffs and note acquisitions
- Joint ventures and preferred equity — through the disclosed route: formal lender consent, market pricing, and full conflict disclosure to your limited partners
- A sale before foreclosure, including structures such as hope notes or profit participation that preserve a path for existing investors
- A negotiated deed back when no carve-out has been tripped
Note that last one: handing back the keys on a clean file has real consequences — a foreclosure on your record, questions about future bankability — but it does not by itself give the lender a right to pursue you for the deficiency. The overwhelming majority of deals getting done now require the buyer, the seller, and the lender all to participate. Lines in the sand do not get that done. Disciplined, transparent negotiation does.
The Other Side of the Coin: Buying in a Distressed Cycle
If you came through this cycle with fixed agency debt and cash reserves, the question is what you are doing with that position. Your next acquisition is less likely to come from a broker’s best-and-final process than from a relationship with a community lender, a bridge lender, an agency servicer, a special assets group, or a receiver.
The prepared buyer’s toolkit: direct note acquisitions at a discount from bridge lenders and community banks, joint ventures into distressed stacks, and discounted payoffs negotiated alongside the existing borrower. Vertically integrated buyers who can actually operate the asset have a real advantage over those who would be stuck servicing debt like a quasi-lender.
On rates: buying into a high-rate environment is a feature, not a bug, provided the deal pencils today. When rates ease, NOI improves, cap compression returns, and exit options multiply. Institutional capital can afford to time the trough; a sponsor going from 30 doors to 300 is not competing with that money and cannot afford to wait. The buyer who makes themselves attractive to the lender and the seller — often by treating existing investors fairly on the way in — is the one who gets the call before the asset hits the market.
Bottom Line: Get Advice Before the Eleventh Hour
The biggest mistake we see is waiting. Most borrowers do not know when a situation crosses the line from manageable to call-a-lawyer, and by the time they reach out, the options that would have saved the deal are gone. The sponsors surviving this cycle are the ones having constructive conversations with lenders and investors now, not the ones waiting for rate relief that is not coming.
If your property is approaching maturity, struggling to service its debt, or showing early signs of stress, start here: pull your loan documents, guaranties, rate caps, property management agreement, and operating agreement. Know your exact maturity date and your current DSCR. Then get experienced counsel involved — whether or not a notice of default has arrived. If you are working through a distressed multifamily asset, you are not alone in it.
Watch the full webinar: Commercial Real Estate Distress: Navigate Market Cycles & Lender Relations with Dugan Kelley.
Need help with a specific property or loan? Schedule a confidential consultation with Kelley Clarke PC to review your loan documents, map your exposure, and discuss the options actually available to you.
This article is provided for general educational and informational purposes only and does not constitute legal advice, and reading it does not create an attorney-client relationship with Kelley Clarke PC. Every property, loan, and guaranty is different; consult qualified counsel about your situation.
