Firm News Real Estate

Real Estate Secured Note Purchases – You’ve Purchased the Note, Now What?

In the first two installments of our three-part series of articles addressing the various issues that arise in connection with real estate secured note purchase transactions, we first discussed the general framework and issues related to all note purchase transactions  and then looked more specifically at issues unique to the purchase of commercial mortgage backed securities (“CMBS”) notes.  This article explores the options available following the acquisition of the note, and identifies some potential pitfalls that note purchasers should be prepared to address.

So, you’ve purchased a note secured by real property – what to do now?  A purchaser acquires the note for any number of reasons, but it will (nearly) always lead to dealings with the borrower.  Upon the completion of the note purchase, the purchaser typically sends the borrower a “hello” letter, putting the borrower on notice that the purchaser has purchased the note and providing the borrower with the contact information for payment and notice purposes pursuant to the loan documents.  The purchaser will likely have determined how it intends to proceed with (or against) the borrower. 

If the borrower declines to cure defaults and offers no agreeable methodology for settling claims, the primary option available to a note purchaser is to institute foreclosure proceedings to acquire title to the real property.  A noteholder should be prepared for the borrower’s efforts to thwart lender’s attempts to secure its rights under the note such as seeking a restraining order or filing bankruptcy. Prior to undertaking foreclosure proceedings or other actions against the borrower, the noteholder should assure that it has analyzed all third party relationships and other property related matters (indeed, these activities are best undertaken prior to the purchase of the note as detailed in our prior newsletter articles). The completion of a foreclosure sale can, under certain circumstances, have unintended and potentially disastrous results. For example, certain leases may be terminated by a foreclosure unless preemptive actions are taken, thereby potentially impacting the value of the asset. If the noteholder has taken the proper precautions, it can exercise all of the remedies available by complying with all requirements imposed by the loan documents and applicable laws related to the foreclosure of real property, such as notices to borrower, filing of the foreclosure action, and undertaking the actual sale, for instance. 

Immediately after the completion of a foreclosure sale, the noteholder will stand as the owner of the property and should immediately take all activities to secure the property and its valuable elements. For example, the noteholder (as the new “landlord” under any leases related to the property) should contact all tenants informing them of its acquisition of the property, directing that rent payments and notices to landlord be sent to the noteholder.  In this regard, it is important to review the provisions of the leases prior to taking any actions to determine any specific language which needs to be included in the letter to assure that the leases are either retained or terminated pursuant to the specific case facts and desires of the landlord.

It should be noted that dealing amicably with the borrower is often possible, and the particular circumstances of a relationship with the borrower may eventually lead to a settlement of a payment of the note at a discounted amount or a “friendly foreclosure” which will save all parties time, money and aggravation.  An option available to all lenders is to determine if any workout can be achieved with the borrower. Given some of the pitfalls and delays which can be involved with the other options available to the purchaser, these types of borrower-friendly transactions can often be the best case scenario, as they can be more expeditious and economical than the more contentious alternatives.

We are hopeful that our three part series has been helpful in addressing the opportunities which can be realized in the acquisition of promissory notes which are secured by real property. The interested reader should understand that these articles have been general in scope given the depth of substance and the varying fact situations potentially involved in these transactions. We encourage any reader which has specific interest and inquiries to contact the authors at their convenience.

By:  Jeffrey J. Porter and Jeff Mosteller

Firm News Real Estate

CMBS Real Estate Secured Note Purchases

In the first installment of our three-part series of articles addressing the intricacies of real estate secured note purchase transactions, we addressed the general implications and structure of a note purchase. While the general framework we outlined in part one holds true for all note purchase transactions, prospective purchasers of commercial mortgage backed securities (“CMBS”) notes must be aware of additional issues that make these transactions unique. In order to better understand how CMBS note purchases differ from standard portfolio loan purchases, one must first understand the structure of CMBS lending.

In a CMBS transaction, commercial mortgage loans of varying size, property type and location are pooled together and transferred to a trust. The trust then issues a series of bonds, which are purchased by investors, and each month the principal and interest payments received from all of the pooled loans is paid to the investors in tiers as bond payments based upon the priority of the investor’s bond. The document which controls how these loans are pooled, serviced, paid to the trust and otherwise handled is called the Pooling and Servicing Agreement (“PSA”).

The primary party responsible for operating a CMBS pool is called the master servicer. The master servicer manages the flow of payments and information and is responsible for the ongoing interaction with each performing borrower. So long as the mortgages which make up the pool perform as intended, the trust will continue to operate under the Master Servicer. However, if a borrower fails to meet its payment obligations, or defaults under a separate covenant of its loan, the trust will assign that loan to a special servicer.

The special servicer is responsible for servicing the defaulted loans, whether such servicing involves a workout with the borrower, the acceleration of the debt, foreclosure of the lien, or the sale of the debt to a third party. Because purchasers of CMBS notes will generally be targeting defaulted loans, the special servicer will be the primary party with whom a purchaser interacts. In addition, one other party will have broad discretion over the fate of non-performing debt in the CMBS pool – the trustee.

Although the trustee’s primary role is to hold all the loan documents and distribute payments received from the master servicer to the bondholders, the trustee is often also given broad authority over the management of the loan pool under the PSA. Generally, the trustee will be an active party in the sale of any non-performing asset from the trust.

Purchases of CMBS notes can fall into one of two paths. First, CMBS pools often have classes of securities with certain prioritized rights, including a right of first refusal on the sale of any assets in the pool. If a priority investor elects to exercise its option, no other party will have the opportunity to purchase the non-performing asset. However, if the right of first refusal is assignable by the priority rights holder, a prospective note purchaser may be able to negotiate with the priority rights holder to have the purchase rights assigned to such prospective purchaser. In this scenario, certain notice requirements pursuant to the PSA must be satisfied and the special servicer and trustee will need to consent to the assignment of rights and ultimate sale of the note.

The second path results when no purchase option exists or, if it does exist, is not exercised. These sales tend to more closely mirror unsecuritized note sales. The special servicer will typically accept bids from prospective purchasers which account for not only the price of the note, but also the purchaser’s proposed due diligence timeline, requested representations from the seller, and other terms which will be unique to each offer. Once the bidding process has closed, the special servicer will consider the proposed offers and select a winning bidder. Upon approval from the trustee, the note purchase can begin in earnest, including any due diligence review and final closing document negotiations.

Once a transaction for the purchase of a CMBS note has closed, the purchaser is the holder of the note and the rights which accompany it. The note no longer has a CMBS character, because it is released from the confines of the PSA upon sale. A purchaser may proceed with post-acquisition activities as it would for any note which had never been part of a CMBS pool.

In the final installment of our three-part series on note purchases, we will evaluate the options available to a note purchaser post-purchase, highlight issues which can arise in servicing the note as its holder and in seeking to enforce rights in the property securing the note, and discuss some potential pitfalls for a note holder.

By Jeff Mosteller

Real Estate

Landlord and Tenant Considerations When Negotiating Economic Concessions in Commercial Leases

Landlords and tenants enter into leases with the expectation that the document which they execute will govern their relationship throughout the term of the lease. However, shifting economic realities may move a tenant to pursue some form of relief from the terms of the lease. It is important to note that while this may initially appear to be a negative for the leasing relationship, it can also prove to be an opportunity for both parties. In order to fully realize these opportunities, there are several considerations landlords and tenants should evaluate.

The starting point for lease modification would naturally be the lease document itself. Both parties should be mindful of the original lease negotiations. Each party likely made concessions during that process, and if a tenant introduces the idea of modifying a provision of the lease (for example, the rent), it is appropriate for the parties to discuss the possibility of other revisions to the lease. Therefore, once a landlord learns of a tenant’s proposal to alter the economic terms of the lease, the landlord should consider which currently unfavorable terms could be modified to make an amended lease more palatable, such as the elimination of a tenant’s early termination right, renewal option, expansion right or other preferential rights or adding restrictions on tenant’s use of the premises. Likewise, before a tenant approaches the landlord for a concession such as rent reduction or abatement, that tenant should “think ahead” and try to anticipate what other favorable terms of the lease could be affected and balance the benefits and drawbacks to each scenario.

Next, the parties must consider the terms of the proposed economic concessions. This can come in many forms, the most common being rent abatement, rent reduction, and space reduction. In these conversations, the landlord and tenant must each have a realistic view of the value of the tenant’s lease. A tenant with a poor payment history or extended financial hardship will have a weak bargaining position. Conversely, during an economic market in which landlords are having difficulty finding new tenants to fill vacant spaces, tenants may have notably increased bargaining power.

While the proposed concession is intended to benefit the tenant, it may lead to opportunities for the landlord to reconfigure its balance of occupied and vacant space. The landlord may wish to reduce a tenant’s space or relocate a tenant to another (perhaps less marketable) location in the project in order to free up the relinquished space to be remarketed or “bundled” together with other space, creating the ability to lease to a larger full-floor/full-building tenant. Each party may also be well served in such discussions to do the other side’s homework for them in advance, including analysis of market rents, the net value of any rental adjustments and any other analysis which may help streamline negotiations.

Once a tenant asks for an economic concession, the landlord is justified in asking to examine the tenant’s financials. An open review of tenant financials will not only help the landlord determine whether to give a concession, but also help determine the amount of any concession. It is also common for such a landlord to then require continued periodic reviews of the tenant’s financials. The parties
should also address other cost saving methods available to the tenant. It will hurt a tenant’s bargaining position if it cannot show evidence that it has taken steps to reduce costs in other areas. The landlord should also take this opportunity to re-evaluate the security the tenant has given to secure its obligations and whether some modification is justified, such as the addition of a personal guaranty or additional security deposit.

Economic recovery by the tenant may trigger the end of any concession provided. In the event of rent concessions, the parties must then consider the concept of recapture. Landlords may expect the tenant to reimburse them for any rent that is forgiven. Once a balance of expectations is considered, the parties should evaluate the multiple options for recapture, such as a simple increase in the base rent at such later time as the parties reasonably project, or, for retail tenants, the addition of, or increase in, percentage rent. Because percentage rent is dependent upon tenant sales, the parties may need to manipulate the breakpoint calculation in order to guarantee repayments.

Finally, there are several issues outside the confines of the actual lease document that both parties must consider when negotiating economic concessions in the lease. First, one or both parties may be subject to loan agreements, and should seek all necessary lender approvals for modifications. Second, a landlord may want to request a waiver of all tenant claims against landlord arising prior to the effective date of the amendment via the inclusion of “estoppel” representations from such tenant. It stands to reason that a landlord that gives relief to a struggling tenant should not fear claims from a matter arising before such relief and the amendment giving tenant its economic concession. Third, any concession should be deemed terminated upon the filing of bankruptcy by a tenant in order to attempt to have the bankruptcy court consider the lease on its original terms during such process.

When tenants face difficult financial times, it is often necessary for tenants and landlords to work together to find a mutually beneficial concession which relieves the tenant’s burden while also adequately addressing the concerns of the landlord. So long as the parties carefully consider the full range of issues involved with such concessions, it can be an important step to securing a positive and sustained economic relationship between the landlord and tenant.

By Jeff Mosteller and Brian H. Baker