May 19, 2020
By Paul Bubny
Since its establishment as a boutique real estate investment banking firm in late 2016, Lotus Capital Partners has put itself on the map with custom solutions to complicated transactions. It amassed more than $1 billion of deals in its first year, and has brought its founders’ deep experience as lenders to the financial advisory conversation ever since. However, the bullish CRE environment in which managing partner Faisal Ashraf launched Lotus is significantly different from the current pandemic-driven uncertainty, and the New York City-based firm has responded with a newly launched restructuring and workout advisory business line. Here, Ashraf provides Connect Commercial Real Estate with insights into navigating through this environment.
Q: We’ve heard a lot about loan forbearance during this shutdown. Will forbearance agreements be the dominant theme in this wave, or is it more likely that we’ll be seeing several types of modification or outcome come into play?
A: Yes, forbearance agreements are definitely the topic de jour. We are in the middle of a few, and it’s clear to us that one size doesn’t fit all. Some are as simple as 90 days of interest deferrals in exchange for the sponsor’s guaranty that they will carry operating expenses at the property. Others are far more complicated, with half a dozen other variables on the table, each of which has a ‘bid’ and an ‘ask’. But stepping back, we are predicting that by the time we get to the other side of the summer, many deals will enter either a second round of forbearance or far deeper levels of restructuring surgeries. I also sense that in many of those instances, both borrowers and lenders will begin asking themselves primal questions about more drastic measures. We expect to see uncured defaults, bankruptcies, notes sales, and foreclosures picking up in the fall should court systems open back up and the economy remain muffled.
Q: Hotels and retail appear to have been most affected during the shutdown. Do you anticipate that as time goes by, you and your team will be working with borrowers across the spectrum of property sectors rather than getting requests primarily for hotel or retail workouts?
A: That’s a great question. I think a few forces will drive the hot spots for distressed debt. First, any asset class where consumer demand is moving in the opposite direction of what the offering is at the real estate level will continue its terminal decline. That means, in those instances, LTV’s only have one way to go. That is fundamentally what’s happening to retail. Years of poor balance sheets (with both corporate tenants and the mom and pops), declining sales, and an uneasy feeling that you’re working for the landlord will continue to feed discontent between tenant and landlord, and then onto landlord and lender. We are advising on a few mixed-use deals where weak collections on the retail components is the reason the deal is under a 1.0x DSCR.
Hotels are a different animal. On a fundamental level, they will remain sound businesses since we’re all social animals by nature who want to continue to travel and crave time away from work (that is, not in our homes!) But the near-term issue is that hotels are notoriously expensive to run. They drive anywhere from 15-25% operating margins to the bottom line if everything is going right. But a 10-20% decline in RevPAR (rate times occupancy) can have owners feeding the assets out of pocket. Now imagine 0% occupancy. At, say, 50% occupancy in 2021, we’ll probably see hotel sponsors needing to put capital into their assets, either at the behest of their lenders or because the asset requires it. We think it won’t be easy to invest capital when you have a 65% LTV loan and you see fundamental residual values down 10-20%.
Q: How are different types of lenders reacting to loan workouts? We hear that some can be more difficult than others?
A: Some might say some borrowers are more difficult than others also. People are people. Currently, we are working across the board with CMBS servicers, debt funds and banks, and I can say that so far everyone is behaving predictably and working cooperatively. That doesn’t mean that we aren’t having difficult conversations. Banks are more lenient, but that makes sense because of certain protections and allowances that are being afforded to them by the federal government. CMBS servicers are largely owned by private equity funds, and they have an obligation to their owners and to the bondholders they represent, so they too are being predicable.
Q: What are some of the workout solutions you are working on right now for borrower clients?
A: • Breaking escrows and utilizing tenant deposits to pay for operating expense shortfalls.
• The deferring of interest payments in exchange for a sponsor guaranty to fund operating expenses, followed by a restructuring of the cash management so there is a trap in place to get the lender whole on their deferred interest.
• Tapping into FF&E Reserves to pay for OpEx and Debt Service.
• Utilizing the government funded PPP loan program to fund shortfalls and debt service at the property.
• Suspension of various covenants such as waivers for closed businesses and financial covenants such as extensions and cash flow tests.
• Extensions of a maturity date and a re-writing of the covenants in exchange for some paydown.
• A deed-in-lieu in exchange for a nominal payment to go away or an upside participation in the property. This is happening in jurisdictions where it’s harder to foreclose and the sponsor still has leverage in that regard.
• On the CMBS side, an interesting one is securing a modification, including in some instances a payment modification under a unique option called a ‘referred’ loan. This is a case where the loan can be referred to the special servicer for more in-depth consultations without technically being in special servicing and incurring those fees. Many borrowers are surprised this option exists.
Q: What is your advice to borrowers facing troubles with their lenders?
A: You mean other than hiring us? Away from any strategic advice designed for each unique situation, I’d borrow an expression from Michael Bloomberg: ‘In God we Trust. Everybody else must bring data’. Start by understanding that lenders, especially CMBS servicers, are custodians of other people’s money. They are very insecure about what they know to be happening at the property and borrower level during times of distress. We recommend that borrower’s clearly organize the nature of their ask, tell lenders what steps they are taking to preserve value at the property, enclose relevant and current financial information, provide specific support such as correspondence with tenants proving issues – in a chart if possible, and prove out the solutions to initiatives they are taking to get ahead of specific issues. In a nutshell, the probability of a lender accommodating your needs goes way up when it starts with an organized, thoughtful, data-driven approach. There is no getting around the difficult conversations that are sure to happen, but this is a game of inches and securing gains starts with Mayor Bloomberg’s mantra.
Q: There are a million brokers out there securing loans for sponsors, but there seems to be almost no one offering them restructuring advisory as a service. Why should a sponsor hire anyone for that matter and why Lotus?
A: I would say a couple of things, all of which are marginal or complete differentiators. Restructuring advisory starts with knowing what makes lenders ‘tick’, which we find central to forging the best compromises. I’ve spent close to 20 years underwriting, structuring, and working out loans while working as a lender and have first-hand experience with tackling problems and solutions from the inside. Others at Lotus embody the same core strength, and we are now bringing those decades of experience to add strength to our borrower clients. I think coming from the lending sector also provides us with some level of moral authority and market credibility in front of lenders since we share a background. As we have found out, a common background helps everyone see a little more clear-eyed as to where the areas of alignment are between a borrower’s ‘ask’ and a lender’s or a servicer’s ‘give’. Lastly, I’d say what we’re most proud of is our ‘solutions’. We’ve built one of the fastest-growing capital advisors in the country by using a ‘solutions’-based approach over traditional relationship banking or brokerage. It forces us – to a sponsor’s delight – to be quicker with numbers, more innovative with the structuring, and altogether more thoughtful with the solutions package.
We love the challenge of helping sponsors on their workouts with lenders. We have a saying at our firm, “if there’s no mud…. there’s no Lotus.”
For comments, questions or concerns, please contact Paul Bubny