Probably because they’ve gotten away with having no specialized tools for the past ten years.  When the market was so hot that property turned a profit regardless of hidden conditions (and even despite obvious ones) in the property itself, or in its numbers, or in the configuration of stakeholders, what did it matter if you used an appropriate tool—or any tool at all—to fix them? 

Now, though, the margin for error is thin.  Far from covering up latent defects in property, information, or structure, the market is exposing them.  Finally, investors are pulling out their rusty toolboxes to fix the obvious problems, but they’re finding only hammers.  Seized by panic, they start swinging because they don’t know what else to do.

While the real estate industry was wheeling and dealing, the financial, legal, and relational structures supporting it became increasingly complex.  Unbeknownst to most investors, their once-simple projects became knit together in a convoluted web of partners, tenants, lenders, vendors, governments, and other real estate investors.  Then, the economic bottom dropped out.  Blindly swinging a hammer at this point may deal a blow that causes the whole house to collapse.

If you are in this situation, don’t panic.  Realize that you are not the only investor in this predicament.  We see it everyday.  Some have greater problems, some have lesser, but all have problems with one or more aspects of their real estate.  Those that think they don’t are deceiving themselves.

Addressing the issues skillfully requires a full toolbox.  It also takes the expertise to use each tool.  And it takes self-awareness to realize when you don’t have the tool or the expertise necessary. 

If you need a handyman, call us.  Elyton Solutions serves real estate investors in a way that you probably have not seen before.  We’d love to tell you about the results we’ve been able to help our clients achieve.

Punxsutawney Phil saw his shadow yesterday morning, so it looks like we’ll have six more weeks of winter.  And if you believe the pundits’ predictions for 2010, looks like we’ll have an extended winter in commercial real estate, too.

Do you feel like Phil Connors (Bill Murray’s character in the movie Goundhog Day), like you’re waking up only to relive the same day over and over again?  Are you mired in limbo, just drifting from day to day, hoping that tomorrow will bring the deal that will jump-start your business?  Have you tried everything—slashing staff, forebearing loans, making concessions, cutting advertising—but nothing has changed? 

Maybe it’s time to do like Phil.  In the movie, egotistic misanthrope Phil Connors finally gets over himself and begins to care for other people.  Hopefully, you don’t have as much personality work to do as Phil, but the principle applies to the real estate business: do things right.

What does that mean?  First, get your business in order from the ground up.  If you’re like most real estate investors, your investments are an amalgam of disparate properties and disjointed entities; find the synergy among them and develop a comprehensive strategic plan to maximize value.  Next, develop a business continuity plan to assure that when you die, you don’t leave a mess for your heirs and business partners to clean up.  Finally, tweak your information systems to deliver more timely, more accurate, and more understandable information.  When you do things right, you’ll make more money from your real estate in less time with less risk.

Take heart: spring is coming.  Despite Punxsutawney Phil’s prediction, it arrives on the vernal equinox every year.  So whether he sees his shadow, and we have six more weeks of winter, or he doesn’t, and we have only six weeks until spring . . . it’s the same difference.  In real estate, too, spring is coming.  Be ready when it arrives.

CLOSE UP – THE CLOCK: The digital clock-radio changes from 5:59 to 6:00.  The radio comes on, playing the chorus of “I Got You, Babe.”  Phil opens his eyes as Rita reaches over him to shut off the alarm. . . .

The immediate and lasting impact of the statement, however, has little to do with flexibility.  It has everything to do with the quality of information provided by borrowers.

Consider the heart of the statement’s guidelines.  For an individual workout to be afforded safe harbor by regulators, the plan must include:

• Updated and comprehensive financial information regarding the real estate project, including current collateral valuations (though a new formal appraisal may not be required in all cases);
• Updated and comprehensive financial information regarding the borrower, including analysis of the borrower’s “global debt service” (i.e., the aggregate of a borrower’s financial obligations, including contingent obligations) that reflects a realistic projection of the borrower’s expenses; and
• Updated and comprehensive financial information regarding any guarantor, including analysis of the guarantor’s global debt service that reflects a realistic projection of the guarantor’s expenses.

In addition, a lender must be able to “monitor the ongoing performance of the borrower and guarantor under the terms of the workout” so that it can modify the workout plan in the future if repayment projections do not materialize or if collateral values do not stabilize.

Lenders cannot take advantage of the flexibility offered by the statement unless they secure this information.  Practically speaking, how can they determine appropriate workout terms without it?  But when lenders have good information in their files, the statement directs regulators to give deference to lenders’ decisions.

Borrowers, you are the ones who ultimately must comply.  But instead of considering compliance a burden, think of it as an opportunity.  Those borrowers who show themselves proactive and forthcoming with information will be treated better than those whose teeth lenders have to pull.  Make your banker’s life easier by appeasing her examiner, and she’ll throw you a bone in return.

The statement merely encourages proper underwriting standards.  Therefore, expect updated, comprehensive, ongoing financial information to become the norm in lending relationships.

***

If you would like more information on how to compile and format your real estate and personal information for your lender and its regulators, please contact us at (205) 533-9261.

What does that mean?  Well, we’re far from out of the woods—in fact, the worst may be yet to come (see, again, The Cycle)—but stakeholders are finally reaching out to each other to try to find a way out.  Rationality is returning.

As we stand together in the middle of the woods, stakeholders are all nursing wounds inflicted by that bear, the economy, and we want to find the quickest path out.  Unlike borrowers, though, banks are still being pestered by those bees, their regulators.  Banks want to escape the bees also.

Fundamentally, it’s the borrower who holds the tools for getting himself and the bank out of the woods.  Borrower, you have the map.  You have a compass.  And you have bee-repellant to relieve the banks.

Your map is your financial statements.  They show both you and the bank where you are.  Lax underwriting over the past few years has left most banks’ loan files incomplete.  Now, regulators are pressing banks to complete them—all at once—and banks are overwhelmed.  Therefore, compile complete, reliable information on yourself and your real estate, and provide it in a format that is detailed, yet understandable.  You can’t move forward until all stakeholders recognize where they are.

As a borrower, don’t hide anything when preparing personal financial information.  Honesty still is the best policy.  Banks are not negotiating with borrowers who seem to be withholding information.  On the other hand, if you demonstrate your lack of ability to repay by disclosing your whole situation, banks will negotiate with you.  Really, they have no other choice.  Regulators will not allow them to foreclose on every property in their portfolios.

Here are some other tips so your offer of information doesn’t get rejected on sight: Back-of-the-envelope deals are not reliable.  Neither is your word, alone, because regulators are skeptical, and they are watching over banks’ shoulders.  And those reams of spreadsheets compiled by your bookkeeper or accountant?  They may be understandable to the preparer, but most are unfriendly to the stakeholders.

Next, pull out your compass, a business plan, and plot a course out of the thicket.  A credible business plan with a definite exit strategy and progress benchmarks along the way is worth far more as collateral to a bank than your personal guaranty.  Your boat and lake-house have zero value in the eyes of regulators.  Regulators want to see a plan for maximizing returns from a bank’s credits.

Information is bee-repellant for banks.  And banks are giving a break to those who proactively provide credible information that the bank can use to deal with regulators.  Some banks are even outright helpful to those borrowers.  With regulators at bay, banks, like borrowers, look at workouts as paths out.

The question is, is the problem fixed?

Let’s assume, for a moment, that simply depressing the lever a couple more times will push the clog through. Some economic indicators (e.g., unemployment trends, productivity increases, factory order increases, housing turnovers) suggest that this is the case. If indeed it is, what does it mean for you, the real estate investor?

It means that you need to capitalize on the recovery. Full analysis of your entire portfolio needs to be done now so that you can (1) maximize the value of your current holdings, (2) prepare for tax increases (someone has to pay the plumber), and (3) present an attractive package to lenders as soon as the credit spigot is turned back on. Interest rates are at historic lows, but they will not remain there for long. Be prepared to act quickly whether you are refinancing or snatching up a new deal.

Beware, though, that the financing packages you’ve used in the past will no longer suffice. Lending standards have tightened, and they will not be loosened just because credit is flowing again. Memory is short, but not that short. All parties must have confidence in the deal. An objective third party with the expertise in presenting all the relevant information in an understandable manner will be the determining factor in getting approved.

But what if that wad of paper snags on the toy that the three-year-old flushed when no one was looking? Or what if the clog runs into a root in the waste line and starts backflowing into the entire house?

If, as some speculate, we are heading for a double-dip recession—the root in the waste line—then we have a serious problem, and fixing it is not going to be pretty. In that event, there is no amount of flushing or chemical that will unclog the line. The only remedy will be to dig up the yard, cut out the root, and repair the pipe.

Don’t be caught with your pants down if a major backflow occurs. We know that we have a problem, so it is foolish to delay-and-pray, hoping that the root is not a root. Yes, there are things you can be doing now to mitigate disaster. First, stop adding to the clog by needlessly flushing more cash. Second, be prepared to overhaul your entire portfolio. If we’re digging up the yard anyway, you might as well save time and money and clean out the whole system at once.
How? Let a team of interdisciplinary professionals who are focused on real estate perform a comprehensive analysis of your portfolio. Get reliable information on which to take action regarding managing cash flow and keeping or disposing properties. And implement properly structured asset protection strategies to protect yourself and your family.

Perhaps, though, a stuck toy is the problem. Over the next three years, an estimated $750 billion of commercial real estate loans will mature. Unfortunately, due to the disappearance of the CMBS market (it’s not just three-year-olds that recklessly play with things they don’t understand), our financial system does not have the liquidity to refinance them, much less originate new mortgage loans. Add in declining rents, increasing vacancies, and rising cap rates, to name a few, and it looks like the toddler has been at it again.

If we find that our near-term economic problems are confined to commercial real estate, then the Fed will concentrate on removing that blockage to clear the pipes so the economy can fully recover. That may mean another credit infusion to dissolve the clog. It may mean installing a fancy S-trap in the form of a "e;bad bank"e; to catch toxic mortgages until they can be properly cleaned out. It may mean that the FDIC and OCC plunge other pipes (i.e., troubled banks) in an attempt to jar loose the clog. At this time, though, all that is speculation.

Regardless of what action the government takes, you should be prepared, knowing that whatever technique is used, your point of contact will still be your lender. Show your lender that you are not the toddler who has clogged his personal toilet, and he’ll turn from you to pursue his problem children.

To prove your innocence, as it were, you need to provide your lender with information he can trust as well as with a viable plan for maximizing his value from your properties. The concept is simple, but the execution is far from easy for most investors. An internally generated rent-roll and your personally prepared financial statement will not cut it. In these times, you need the assistance of a credentialed third party in preparing your information and presenting your plan in order to give them sufficient credibility.

The economy will eventually clear the clog. Make sure that you don’t get flushed out with it.