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Commercial Real Estate: What you Need to Know. North Carolina CCIM State Gathering Presentation by: Jay Rollins September 24, 2010. Today’s Presentation. Commercial Real Estate Market Outlook Distressed Assets: What you Need to Know Loan Workouts and Recovery Primer

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commercial real estate what you need to know

Commercial Real Estate: What you Need to Know

North Carolina CCIM State Gathering

Presentation by: Jay Rollins

September 24, 2010

today s presentation
Today’s Presentation
  • Commercial Real Estate Market Outlook
  • Distressed Assets: What you Need to Know
  • Loan Workouts and Recovery Primer
  • Adapting to the New Market Environment: Making Money
  • The New Underwriting: How Lenders are Analyzing Deals
  • Questions & Wrap Up
the past1
The Past

There is $1.4 trillion of commercial real estate debt that is coming due over the next few years. This represents 40% of all commercial real estate debt. With values down 30-40%, most of these loans cannot be refinanced at par.

the present1
The Present


Community Banks: They are holding onto their assets because they cannot afford to sell at market prices. If they do so, they risk being insolvent. The FDIC is not aggressively closing banks. They are aggressively putting banks under operating agreements. It is hard to do business with community banks.

Large Regional Banks: These banks are overburdened with legacy loans and REO. They have been able to raise equity or have received TARP funds, so failure is unlikely. They are shedding real estate assets because they are profitable in other areas. LARGE REGIONAL BANKS ARE THE BEST TO DO BUSINESS WITH.

Money Center Banks: They typically hold larger assets, and will primarily extend/pretend because they can. Money center banks hire bulk advisors.

the present2
The Present

Other Lenders

Private Lenders: In the “go-go” credit years, private lenders were forced to do the most risky deals as securitization took away their traditional transaction base. They are now in workout mode, and they will restructure.

CMBS: The flood gates are opening and CMBS defaults are rising quickly. Special servicers have more problems than people to deal with them. This is a significant opportunity. CMBS LOANS ARE FORECLOSING, CREATING REO OPPORTUNITIES.

Life Companies: There is not a lot of distress in these portfolios. They will typically cure their own problems on a situational basis. THERE IS NOT MUCH OPPORTUNITY WITH LIFE COMPANIES.

the future1
The Future

What will the commercial real estate finance landscape look like?

We are back to balance sheet (hold the risk) versus syndication (sell the risk).

Less capital available: Less capital in the market going forward, as a record amount of legacy debt is maturing.

  • CMBS: The highly reliable CMBS market of $150-200 billion of annual liquidity is gone!
  • Wall Street: The Wall Street lending machine (investment banks and hedge funds) is gone and/or shrinking.
  • Banks: The banking system is burdened by toxic legacy assets.

More equity required by lenders in the market:

  • Old model: 10-20% equity. New model: 40-50% equity.

Tougher underwriting by lenders in the market: Tougher standards for securitization- the lenders will hold some risk.

  • Tougher analysis on future occupancy assumptions
  • Tougher analysis on future rent assumptions
new capital entrants1
New Capital Entrants
  • Public Non-Traded REITs: This is a new market player to watch. Its very expensive to launch these vehicles ($10 million). They typically have to return 8-9% to their investors, so expect loan rates in the 10% range.
  • CMBS, take two: CMBS will be back, but it will look very similar to how it started in 1999. Very conservative, and only for core assets with good rent rolls.
  • Private capital: Expect to see a rebirth of private capital. This will come from a variety of small funds/asset managers across the country. SEE JCR CAPITAL.
why real estate deals go bad
Why Real Estate Deals Go Bad
  • Bad sponsors: Incompetence, lack of experience, weak people in bad market.
  • Too much time: Time kills all deals.
  • Costs were under estimated: Increase costs without increase in revenues.
  • Key leasing or sales did not occur: Did not generate pro forma revenues.
  • Property overleveraged: What percent of the business plan is needed to be achieved to pay off debt. See key leasing bullet points.
  • Market conditions change: Demand weakens or credit terms tighten.
loan defaults1
Loan Defaults
  • The senior debt: In the best position. Will seek a foreclosure or note sale quickly.
  • The senior bank lender will typically avoid REO.
  • The CMBS lender will typically want REO:
        • More value
        • More fees
loan defaults2
Loan Defaults

The mezzanine lender: In the worst position.

The three options are:

  • Pay off senior lender – need capital
  • Assume the loan (if allowed by the Intercreditor Agreement)
  • Try to have capital call on sponsor (unlikely)
loan defaults3
Loan Defaults

The Limited Partner equity has very little recourse.

The options are:

  • Take over as General Partner
  • Write fresh checks to cure debt defaults
loan defaults4
Loan Defaults

The sponsor:

  • Behavior is key: Good guy vs. bad guy
  • Cooperative vs. difficult
  • Problem solver vs. deer in headlights
note sales1
Note Sales
  • In some cases the first trust lender or the mezzanine lender will seek to sell their note at discount, take the loss and walk away.
  • Buying non-performing or sub-performing loans is a business all to itself.

(Continues on next slide)

note sales2
Note Sales

Key issues of Note Sales are as follows:

  • Assignment of the note: The buyer “inherits” the existing note “as is.” Thus, all of the terms are pre-set. The buyer must be comfortable with the remedies, default rate, recourse, etc.

(Continues on next slide)

note sales3
Note Sales
  • Reps & warranties: Typically only rep will be the validity of the note
  • Note buyers worrying about previous bad actions, promises, etc.
  • Note sales at discount give the new lender more flexibility to work out an amicable solution (lower basis).
  • Pay special attention to default provisions, cure provisions, and default interest rates.

(Continues on next slide)


Foreclosure is an excellent way to “cleanse the asset.” It extinguishes all claims and liens and is a great tool for transferring assets.

The Process: Driven by state law. Know your state law before lending or buying notes

Judicial vs. Non-Judicial Foreclosures:

  • Judicial foreclosure: A full blown legal process with a judge, a hearing, and a court date. Takes up to one year, very easy to stall.
  • Non-judicial foreclosure: Public notice, then sale at court. Takes 30-60 days.

(Continues on next slide)


Mezzanine Foreclosures: A “UCC” process

  • This is an administrative judicial process
  • The lender “instantly” becomes the borrower

Unsecured liens: They are wiped out or “cleansed” at the foreclosure process.


Bankruptcy is a borrower option once the loan is defaulted on, and prior to foreclosure. You can never negotiate away the right of bankruptcy.

  • Bankruptcy law is a combination of federal law and state law.
  • Bankruptcy outcomes are greatly influenced by the bankruptcy judge and the leniency of a particular court.

Keys to Bankruptcy Analysis

  • Special Purpose Entity: Also known as a single purpose entity. Avoids the co-mingling problem.
  • Real Project Equity: Can create a problem for the lender – susceptible to a cram down plan.
  • Bankruptcy Plan: Every bankruptcy has to have a plan submitted by the borrower. The plan must show equity in the property and how they can pay off creditors.
  • Motion to Lift Stay: This is the lender asking the court to “throw out” the bankruptcy filing due to lack of merit – this is rare.
  • Debtor in Possession Financing (DIP): Lending to bankrupt entities as part of a cram down plan – this is great business. The DIP lender is paid first. (JCR Capital will provide the loans.)
today s market
Today’s Market
  • An historic opportunity
  • Where were you in 1992?
  • Now is the best market for those with intellectual capital
what drives asset values today
What Drives Asset Values Today?
  • Rev Par ?
  • NOI ?
  • Price per foot ?
  • Appraisals ?
  • Replacement Costs ?
  • Markets ?
  • Revenue Streams ?
leverage examples
Leverage Examples

All equity purchases

  • Cap Rate = ROE
  • Cash on cash return is unleveraged
  • The return is the cap rate (unleveraged)

95% leveraged purchase

  • Key go/no go “number is the leveraged ROE
  • Leveraged ROE increases with debt
  • As leveraged ROE increases, sellers will pay more
  • Prices go up and cap rates go down
leveraged roe old vs new
Leveraged ROE: Old vs. New

Price $10 Million

Interest Costs

First: $8MM @ 5% = $400,000

Mezz1: $1MM @ 9% = $90,000

Mezz2: $500K @ 13% = $65,000

Total Interest $555,000

Price $10 Million

Interest Costs

First: $7MM @ 6% = $420,000

Cash Flow

NOI $ 650,000

Cost ($ 555,000)

Net Cash Flow $ 95,000

Cash Flow

NOI $650,000

Cost $420,000

Net Cash Flow $230,000

Leveraged ROE

$95,000/$500,000 = 19%

Leveraged ROE

$230,000/$3,000,000 = 8%

leveraged roe old vs new1



Adjustments required for new

Adjustments if cash


Cap Stack

Cap Stack

capital stack to meet old returns

flow declines 15%




$7MM (price decline: 30%)

$6 MM (40% decline)





(cap rate 9.3%)


(cap rate 6.5%)

(cap rate 6.5%)

(cap rate 9.2%)






Leveraged ROE






Change in leverage takes property value down 30%

Change in leverage and 15% cash flow decline takes property valu

e down 40%

*Both changes are based on cap rates moving from 6.5 to 9.2%.

Leveraged ROE: Old vs. New
intellectual capital is back
Intellectual Capital is Back
  • No more “golf and cigar” guys
  • No more Rolodex bonuses
  • The smarter guys will be the winners
the total strategy approach1
The Total Strategy Approach

Understand the options at every level of the deal.

Think in terms of these three buckets:

  • Asset level issues
  • Debt issues
  • Equity issues
the asset
The Asset

Asset Status:

What is the current state of:

  • The physical asset
  • Rent roll quality
  • Competitiveness: Price/function
  • NOI trends
  • What is the current status of the debt?
  • When is the debt due?
  • Are there any extension options?
  • Is the loan in default?
  • Is the loan in special servicing?
  • Has the lender taken a write down?
  • How much equity is currently in the deal?
  • Where did the equity come from?
  • Sponsor
  • Institutional
  • Limited Partners
    • Do you anticipate future capital calls?
strategic alternatives
Strategic Alternatives
  • Negotiate extension with lender
  • Negotiate a discounted payoff with lender:
    • New debt
    • New equity
  • Sell the asset
  • Sell the asset with carry back:
    • Sponsor carry back
    • Bank carry back
  • Refinance the senior debt
  • Refinance the junior debt
  • Restructure the senior debt
  • Restructure the junior debt
  • Bring in new equity partners
    • Into the partnership
    • Buy the note at a discount
  • Bankrupt the property: Restructure via the courts
seller s representative
Seller’s Representative
  • It will be critical for you to manage the expectations of your client over the next year. There is a gap today between buyer and seller perceived values. To help bridge this gap, use your knowledge of capital markets and show the seller the buyer’s pro forma.
  • If using the “new underwriting” metrics we discussed (80% LTV constraint / 1.25x DSC constraint / 8% loan constant), and the buyer’s pro forma is not achieving a mid-teens leveraged ROE, then your seller’s pricing may be too high. Other points to consider:
    • Rent Roll: Is it ready for sale, or should you spend some time cleaning it up?
    • Owner’s current financial situation:
    • Why are they selling today?
    • Is the loan on the property due?
    • Can it be refinanced in today’s market?
    • What are the alternatives if the property does not sell?
    • Current financing: Is it assumable? A conduit loan made in 2004-2007 with an assumption option and good terms, could increase the value of the asset today.
buyer s representative
Buyer’s Representative

The market is changing. Values are dropping and deals require more equity. Make sure you are working with knowledgeable, qualified buyers who can bring 20-25% equity to the deal. Other things to focus on:

  • NOI: Focus on the trailing-12 month NOI, not pro forma NOI.
  • Rent Roll: Understand the tenant mix, and discount the revenue from tenants who may not qualify for underwriting purposes (i.e. month to month tenants, those with escape clauses, etc.) as this income will not be “counted” by the lenders.
  • Debt: Understand if the property will:
  • Need a bridge loan or will qualify for permanent financing
  • Return thresholds: Have this conversation up front about buyer’s return expectations so you can solve for the leveraged ROE, and make sure you have realistic return expectations and sales price.
  • Roll schedule: Should be staggered.
  • Occupancy: The more the better.
  • Tenant quality: Look at the income statement, balance sheet and sales per square foot.
owner s representative
Owner’s Representative

You may want to begin the pitch talking about the owner’s financial positions in the building, before discussing space or vacancy. Understand what the building financial situation is, as this may drive the type of tenants the owner will seek. This “thinking like the owner technique” will differentiate you from the competition. Good questions are:

  • What are the owner’s long term objectives with the building?
  • When is the loan on the building due?
  • If the loan is due soon, have they run a refinance pro forma under today’s new stricter credit guidelines?
  • If the loan is due soon, can it be easily refinanced based on the current roll, or is the leasing and current vacancy going to materially impact the ability to refinance?
  • Is the current loan a conduit, bank or life company loan?
tenant s representative
Tenant’s Representative

In these situations, you may have to “reverse engineer” the potential building your client’s are looking at. You can help dive a better lease for the client if you know the situation of each building’s owner. Things to think about are:

    • When is the loan on the building maturing?
    • What type of financing is on the building (conduit, bank, life company, etc.)?
    • Does the building have secondary debt (mezzanine loan)?
    • When was the loan made (look for when it was last sold)?
  • What you are trying to understand is how critical your lease may be to the building’s short term financial health of the current owner. The more critical your deal is to the building’s overall financial health, the better transaction you can negotiate for your tenant clients.
investment metrics
Investment Metrics
  • Investment basis: Investment basis will typically be measured on a per foot or per door basis. JCR will seek to make investments at or below replacement cost.
  • Cash flow to investment basis on income based investments (income properties): JCR will seek transactions that can provide current or near term cash flow of at least 8% return.
  • Stabilized cash flow to investment basis (income properties): JCR will seek investments that can provide pro forma “stabilized” cash flow to investment basis of at least 12%.
  • Net operating income analysis: JCR will thoroughly analyze each potential investment and perform due diligence on the historical, current and future project net operating income.
investment metrics1
Investment Metrics
  • Quick sale value: For each investment, JCR shall determine the asset’s “quick sale value.” JCR will seek to make all of its investments below the asset’s quick sale value.
  • Ownable basis: In all investments, JCR will underwrite the investment where it would be comfortable owning the asset.
  • Market recovery investments: In some cases, especially with non-income producing assets, JCR will be relying on a sale at market recovery for investment realization. In these cases, JCR will underwrite submarket supply and demand, asset quality, and location. JCR will also pro forma conservative exit values, which will typically be less than 80% of prior peak values.
  • Sponsorship: JCR will also endeavor to make loan investments with credit worthy sponsors and will underwrite approved sponsor's ability to manage and operate the underlying assets.
jcr capital at a glance
JCR Capital at a Glance
  • Flexible structures
  • Investments do not require current pay
  • Investments can be structured as debt or equity or a hybrid
  • Can close quickly
  • Can be short term: 6 months or mid-term 3 years
  • Non-recourse
  • Rate: Can be as low as 10%
  • All in return requirements: 15-20%, can be achieved via rate, fees, or profit participation in various combinations.
  • We typically do not like to be subordinate to other debt
  • Preferred deal size $1-10 MM
jcr capital seminar series
JCR Capital Seminar Series

Course 1: Stabilized Commercial Properties

Buying, investing & financing stabilized properties

Course 2: Value Added Commercial Properties

Creating wealth through commercial real estate

Course 3: Mezzanine Debt & Joint Venture Equity

Joint venture equity & mezzanine debt

Course 4: Opportunistic Real Estate Investment:

Investing in distressed assets, land & condos

Course 5: How to Make Money in a Down Market

How to find and take advantage of opportunities in a down market

Course 6: Starting a Fund 101

Everything you need to know to start a real estate fund

How to buy: Contact Tara Eisler –

  • DVD courses
  • Online courses