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Reprinted from Scotsman Guide Commercial Edition and ScotsmanGuide.com, July 2020

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The COVID-19 crisis has upended the commercial real estate market, forcing borrowers, lenders and mortgage bro-kers into territory they haven’t seen in years. These hard times also mean that commercial mortgage professionals must relearn the lost art of loan workouts.

Many commercial-property owners will need rescue � nancing from new eq-uity investors. You can help structure and broker these deals as a way to make up for lost commissions. But you also should consider taking the idea of rescue � nanc-ing one step farther — negotiating an ownership stake in the properties that you help to save.

As a result of the coronavirus outbreak shutting down the U.S. economy, many commercial mortgage lenders have stopped making new loans. They are fo-cused on the precipitous drop in their existing borrowers’ revenues and how that will impact their own loan portfolios. Accordingly, with limited opportunities to earn commissions from brokering new loans, commercial mortgage brokers will need to adjust their business models to replace lost income.

Ron Zimmerman is president of NetLeaseX Capi-tal LLC, an investment-banking and capital-markets advisory company in Cincinnati. Zimmerman specializes in sourcing and structuring debt and equity � nancing for commercial real estate inves-tors and developers. He has more than 33 years of experience in the commercial and residential real estate markets and is a licensed real estate broker. Reach Zimmerman at (513) 621-1031 or ronz@netleasex.com.

Throw Out A LifelineCommercial mortgage brokers can be frontline emergency fundersBy Ron Zimmerman

One way for brokers to keep fees � ow-ing is to help their clients raise funds to cover operating losses or fund an interest reserve. By raising badly needed funding or rescue � nancing, mortgage brokers can provide a much-needed service to their clients, many of whom may be at

By Ron Zimmerman

PresidentNetLeaseX Capital LLC

risk of losing their properties to foreclo-sure. A client’s losses could be further compounded if resulting foreclosures create personal liability under any loan covenants and if their properties need to be sold at � re-sale prices.

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Reprinted from Scotsman Guide Commercial Edition and ScotsmanGuide.com, July 2020

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Despite the considerable amount of res-cue funding that many clients may need to raise, standard commission rates prob-ably will not produce the same amount of income as brokering multimillion-dollarloans does. Therefore, in order to appro-priately compensate brokers for theirvaluable work, a more creative approach to compensation may be required.

Throwing a lifelineAs a way to help clients successfully raise rescue financing and save their properties from foreclosure, mortgage brokers may be able to negotiate a purchase of, say, a 5% ownership stake in their client’s property, in addition to or in lieu of earning loan commissions. Over time, once the property value re-covers, a mortgage broker’s ownership interest may become more pro� table than the cash commissions that could be earned in pre-coronavirus days.

Many commercial mortgage brokers, however, will need to relearn the nuances of the distressed-property market. With real estate experiencing a bull market for the past 10 years, understanding and having experience in loan workouts has become a lost art. Times have changed nearly overnight. A large number of ten-ants are expected to stop paying rent. Even investors who own institution-al-quality real estate investments are un-likely to receive su� cient rent payments and other sources of ancillary revenue to cover their operating expenses and mortgage payments.

Given precipitous drops in property rev-enue, many investors have been reaching out to their lenders for help. Lenders may agree — or be required — to o� er for-bearance to their borrowers, which has oc-curred on government-backed multifamily loans through Fannie Mae, Freddie Mac and the U.S. Department of Housing and Urban Development. Even in these cases, however, a lender’s help will be limited.

Typically, lenders o� er to add the unpaid interest onto their borrowers’ loan balances. This solves a problem in the short term. Borrowers don’t have to make mortgage payments. Over the long term, however, borrowers need to raise additional funds to increase their working capital and leasehold improve-ments for new tenants who will replace the ones that either downsize or go out of business, and/or to pay for the leasing commissions.

Also, some real estate owners may see this time as an opportunity and look to raise new funding to buy out existing limited partners, cover unfunded capital calls from limited partners or to pay cer-tain tenants to give back leased spaces. By raising rescue � nancing, your clients may be able to use an infusion of cash to gain leverage in workout negotiations with their senior lenders. For example, the current borrower and the new investor may be able to negotiate a lower interest rate, an extended maturity date and/or a release or reduction of the borrower’s personal loan guarantee.

The Bu� ett precedentCommercial mortgage brokers can draw on a precedent established by the famed investor Warren Buffett. Dur-ing the financial crisis of a decade ago, Buffett negotiated a number of multi-billion-dollar investments in blue-chip companies, including Bank of America, Goldman Sachs and General Electric. In each case, Buffett got the companies to issue preferred stock to his holdings company, Berkshire Hathaway. This pro-vided for an attractive preferred return rate, plus long-dated warrants to pur-chase the companies’ common stocks at depressed prices.

By receiving preferred stock, Buffett’s investment was senior in priority to all of the common stock holders if the companies were to file bankruptcy and subsequently reorganize or liquidate.

Buffett ultimately earned lucrative pro� ts on his preferred stock investments when the companies recovered and the war-rants increased in value as the companies’ common stock increased.

In the same fashion, investors inter-ested in providing rescue � nancing in today’s commercial real estate market would likely structure their investments similar to Bu� ett’s. That is, with the ad-age of “last money in, � rst money out,” investors would expect to be paid back � rst before the owners receive any pro-jected pro� ts, along with receiving an equity kicker just like Bu� ett received with his warrants.

Instead of receiving warrants like Buffett, however, real estate investors would likely have the right to purchase an interest in a property. To do so, as-suming that the ownership entity is a limited liability company (LLC), the bor-rower and investor would either amend or replace the existing operating agree-ment. This agreement would specify that the LLC issue common membership interests to the investor that specific, for example, an ownership share. Likewise, given the value of the mortgage bro-ker who secures rescue financing, they could purchase a small ownership inter-est in the LLC.

Assessing deals Rescue-� nancing deals can be struc-tured in many ways. These types of deals, however, must begin with a care-ful analysis. In addition to normal and customary due diligence, investors who are considering an infusion of rescue � -nancing will want to analyze a number of factors about the property and your client’s � nancial situation.

First to consider is whether the prop-erty’s rent prices, occupancy rates and operating expenses are expected to revert back to pre-coronavirus levels.

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<< Continued

If not, you need to estimate what the net operating income will be once the asset is stabilized under the new arrangement, and how the new income levels will af-fect the property’s fair market value.

Another major consideration is the exit strategy. How long will it take be-fore a buyer can obtain debt � nancing to purchase the property and how much debt will be available for the prospective buyer? In other words, what is the likely loan-to-value ratio? Also, when commer-cial real estate markets normalize, will buyers demand higher capitalization rates than they did prior to the outbreak? This might lower the � nal sales price and a� ect your return on investment when you cash out of the deal.

Furthermore, you will need to consid-er whether the � nancial deterioration of tenants will cause buyers to demand a higher capitalization rate. And � nally, what return will equity investors demand to invest in stabilized properties given the opportunity to invest in more oppor-tunistic, distressed assets? Based on the above analysis, investors will determine their perceived risk in providing rescue � nancing and, therefore, where to invest in a property’s capital stack.

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For the foreseeable future, real estate owners will need to raise rescue � nanc-ing to stabilize their properties. Com-mercial mortgage brokers should under-stand how loan workouts are conducted, identifying new sources of rescue � nanc-ing and how to structure such deals to everyone’s mutual bene� t. You will cre-ate goodwill with your clients while earn-ing fees and, if negotiated appropriately, acquire a pro� table interest in your bor-rowers’ assets. ●