Unexpected Financial Stress – Is a Commercial Property Foreclosure Your Only Option?
In this post-COVID world, the uncertainties of the pandemic have brought challenges to even the most solid businesses. Property owners may suddenly find themselves straining to pay the mortgage on their commercial property. With a payment that may seem insurmountable, some might simply consider conceding to commercial property foreclosure.
We urge you to consider this only as a last resort. Commercial property foreclosures can seriously jeopardize not only the financial state of the business but also that of the owner. Many commercial property loans require personal assets as collateral for the loan, including your personal residence, and these can be legally seized upon a foreclosure.
Some lenders may even have grounds to sue you if the amount they recover from the property does not cover the debt still owed.
Fortunately, various other options can be pursued first, the chief among them being selling the property before foreclosure looms. Below we have provided a quick overview of the possibilities available should you find yourself facing foreclosure. However, we always recommend that any decisions of this nature be met with the professional guidance of a real estate attorney who specializes in these methods.
Alternatives to Commercial Property Foreclosures
Forbearance
A forbearance agreement between lender and borrower acknowledges the reality of the borrower’s default and establishes that the lender will refrain from seeking due remedies immediately so long as certain conditions are being met within a defined timeline. As this is an individual agreement between the lender and borrower, the conditions vary with each situation.
The lender does not sacrifice the right to seek remedies, but rather allows time for the borrower to improve financial stability and deliver payment. Forbearance agreements have increased considerably through the COVID-19 pandemic. Many lenders see the financial misfortunes of their borrowers as a temporary setback for otherwise solidly producing businesses and would rather extend a period of grace than lose the relationship altogether.
Loan Modification
Of a more permanent nature, loan modification occurs when the lender agrees to modify and restructure the terms of the mortgage loan. This could include extending the life of the mortgage, waiving late fees, lowering the interest rate, or reducing the monthly payment. All changes are aimed at providing the borrower with more affordable monthly payments.
Short Sale
A short sale is also a negotiated agreement between the lender and borrower, but this results in the sale of the property not just restructured loan terms. In a short sale, the borrower sells the commercial property for less than the amount still owed on the mortgage, and the lender agrees to accept less for the loan repayment. While this is better than a commercial property foreclosure, it still can have considerable negative side effects for the borrower – namely a hit to their credit.
Deed in Lieu of Foreclosure
This method involves the transfer of the property title back to the lender, typically affording the borrower a release from the debt liability. Some lenders even prefer this arrangement as it allows them to avoid time-consuming and costly foreclosure proceedings. This also makes the transfer of tenant files, leases, and other obligations a much smoother process.
Bankruptcy
Chapter 11 Business Bankruptcy is a legal process by which a business may declare bankruptcy but continue to operate the business within certain guidelines. Chapter 11 bankruptcy provides the opportunity for an owner to reorganize the business in order to keep operations alive. This typically also involves a plan for paying creditors over time. A bankruptcy certainly has negative effects on one’s credit rating; however, some lenders look at a Chapter 11 bankruptcy with more favor than a commercial property foreclosure.
Sell Before Foreclosure
Selling your property first is always the best option. Speed is of the essence in this situation, therefore, logistical affairs should be put in order as soon as possible. There is much that can be done to help expedite the process and produce the needed sale. Your broker will be familiar with each step and can help guide you through the process.
Below are six quick and simple tips to remove roadblocks and assist in the sale of your property:
1. Order the Title
A title report can take 7-10 days for delivery, so it’s important to get this process started promptly. Talk to your real estate broker about ordering your title immediately.
2. Produce Service Records
Hopefully, you’ve kept detailed records of your property maintenance and repairs. Any documented history you have on electrical, plumbing, HVAC, roofing, window, parking lot, and various other service history records are helpful as your broker presents your property to potential buyers. This information will likely be requested during the process anyway, so having it readily available eliminates wasted time.
3. Organize Rent Roll
Any potential investor will want to know the return on investment (ROI) of the property in question. If you have tenants in your building, you’ll need to deliver an organized rent roll of all the current tenants. This should include the length of their term remaining and any terms and conditions of their lease. Also include any other sources of revenue from the property such as vending machines, laundry fees, CAM fees, etc. This is in essence the Net Operating Income of the property. Back these figures up with the last 2 years of profit and loss statements. If you don’t have these documents, or if they could use brushing up, your broker can help compile them.
4. Current Environmental Inspection
Many banks will require an environmental inspection in order to underwrite the loan. This is especially common with SBA loans. If you don’t have an environmental inspection, or if your environmental inspection is older than 6 months, you can talk to your broker about preparing to order this report right away in order to prevent the process from causing delays later. These can take a few weeks at least, and a lender will want assurance that the property does not contain environmental issues. In many cases, however, the buyer will be required to have their name or the name of their lender on the inspection. While this may prevent completing the environmental inspection up front, doing the leg work ahead of time can be helpful. Your broker will have relationships with environmental inspectors they can recommend.
5. Identify the Cash Price
If you’re able to take less than market value (i.e. if you owe less on your mortgage), set a minimum cash price for the property. Your broker can give you an opinion of market value, but your internal financial requirement is also important. If a quick close is the priority, consider pricing your property below market to attract cash buyers and investors who can close more quickly. The financing process can add many unexpected setbacks, especially with owner-user loans which are often underwritten by the SBA, sometimes drawing out the closing for 3-4 months. Cash buyers are especially ideal when you are facing potential foreclosure.
6. Find the Right Broker
The right commercial real estate broker can make or break your transaction. Find a broker that is well connected with a strong network of investors, financial institutions, surveyors, environmental inspectors, and other commercial brokers. They may have a buyer that has been waiting for the type of opportunity you present. Good brokers will know how to successfully navigate the various financial hurdles you are facing from your looming foreclosure. A quick call to a local broker can help bring perspective on your situation and get your questions answered.
In the end, commercial property foreclosures are not the only answer to financial duress in your business or property. For more information on the options available to you and the methods we use to quickly sell a property, call us at 719-227-9987.