Real Estate Receivers in the Credit Crisis and How Commercial Agents Will Benefit From Working with Them
11/18/2009 20:35
| By Stan Mullin, FRICS, SIOR, CRE, CCIM We know our economy is in the grip of something entirely different than in the recession in the late ‘80s and early ‘90s (in 1989 alone, 534 banks failed). That recession was limited to a collapse in the real property market. Our current economic troubles are a credit problem and credit is the financial “air we breathe” and no one is unaffected. Who are these receivers that we are beginning to read about and why should we care? In short, because they are the people that will have responsibility for many of the income property and for sale housing projects that are going through foreclosure. They will be hiring real estate agents, property managers and other third-party service providers to complete, lease, sell and manage the property under their care. They are a source of commission income. Let’s first look at the scale of the commercial real estate problem. In the fall of 2007, the collapse in mortgage-backed securities created out of home loans played a big role in undoing the residential sector of the U.S. economy and triggering the global economic recession. Federal Reserve and Treasury officials today are scrambling to prevent the commercial real estate sector from delivering what has historically been an even greater negative impact to the economy. Of the $6.7 trillion in commercial real estate that is privately owned, banks hold between $1.3 - $1.7 trillion (50 percent) in commercial mortgages and construction loans. In addition, commercial-mortgage-backed securities (“CMBS”) comprise another $700 billion (22 percent) in outstanding debt, life insurance companies 9.5 percent, government sponsored entities/agency and GSE 9.5 percent, and savings institutions 9 percent, most of which was originated during the 5-year period from 2003-2007. In many cases CMBS was used in hard-to-finance acquisitions (either involving higher loan-to-value ratios or providing debt in markets and on assets that conventional lenders would not finance). CMBS default rates now are rising dramatically as the following charts indicate because of overly optimistic underwriting (that rents would continue to rise) and the inability of property owners to refinance loans bundled into CMBS (even though the cash flows on many of these properties are enough to pay interest and principal on the debt).1 The worry today is that rising defaults on CMBS debt will pull down values on CMBS financed collateral and in turn, have a cascading effect on bank financed loan collateral, leading to an increase in the default rate of bank loans (banks are deleveraging and want more equity). McKinsey Research recently estimated the total CRE loss at commercial banks during the next two to three years to be $430 billion, of which less than 10 percent had been taken by August 30, 2009. In short, it looks like commercial defaults will continue to increase this fall (to date, the default or bankruptcy of properties owned by Opus, General Growth, Maguire, Tishman and other reputable firms has already occurred), beginning with retail and hospitality properties and then multi-family, office and industrial product. Commercial brokers that have historically called on tenants and landlords will find that their new customers are receivers and bank REO departments.  Rents, Issues and Profits Receivers (“Receivers”) are, in most cases (it varies by state), individuals that are nominated in an appointing order drafted by the plaintiff’s legal counsel (typically the lender) which in most cases is approved and appointed by the court (a judge in the jurisdiction of the loan collateral) to “protect, preserve and secure rents after a loan default, during a foreclosure.2 If the Receiver is successful, in most cases the loan collateral will have retained its value from the time of the filing of the Notice of Default (“N.O.D.”) until the foreclosure is complete. If so, the ultimate deficiency to the owner/borrower will be minimized and proceeds on subsequent sale by the lender (whether sold during or after the receivership) are maximized.Most Receivers are attorneys, and the remainder are a blend of CPAs, property managers, developers and others that can show to the court (presiding judge) that they are competent to preserve the value of the asset during foreclosure. Why are there typically specific performance provisions in the deed of trust or assignment of rents clauses in loan documents that provide for the appointing of a receiver? Because lenders fear that when an owner/borrower (typically the defendant in the foreclosure action) receives his N.O.D. from the lenders trustee (typically a title insurance company that is substituted in, prior to the filing), the borrower will:
Who does the receiver work for? The court. Even though the receiver is typically nominated by the lender (either a bank or CMBS special servicer), the Receiver is an agent or officer of the court, is a neutral third party and his or her authority is limited to the terms and conditions in the appointing order. To that end, Receivers will often work with the plaintiff’s counsel in the drafting of the appointing order to insure that the authorities provided in the order will allow the Receiver to complete their work without having to come to the court (the approving judge) for routine decisions required in the performance of their work. Before the receiver can be appointed, he or she must obtain a receiver’s bond (which is typically equal to the value of one month’s rent). How and when are Receiver’s paid? Their billing rates are delineated in the appointing order. In some cases it is a fixed fee with certain exceptions and in most cases it is an hourly rate which varies depending on the level of experience of the person involved in the receivership work (receiver and support staff). In most cases the receiver submits his or her billings to the judge, the plaintiff and defendant at the end of each month and if the judge, the plaintiff or defendant do not object to the charges (10 days is a widespread waiting period), the receiver is free to deduct said funds from his or her receivership estate account. Where does the money come from to pay the receivership estate fees? Either from funds transferred from the borrower/owner/defendant’s property bank account, rental income or funding of the receivership estate’s bank account through receivership certificates. Prior to accepting a receivership, the receiver should have the assurance that there will be sufficient funding to the receivership estate’s bank account to pay their fees. When are receivers appointed? Typically, concurrent with the noticing to the borrower of the N.O.D. It is not uncommon that on the day of the appointment, the receiver will notice the owner/borrower of their appointment, make a demand for all documents related to the property and submit a request to the owner/borrower’s bank to place a hold on their property bank account and a demand to transfer to the receiver’s property-specific bank account an amount of funds equal to the security deposits, one month’s rent (from all tenants) and a month’s operating expenses. Although the borrower/owner retains title to the real property until either the foreclosure completes, or a work-out (or the cure of the underlying default) is affected, the receiver takes possession of the asset (collateral). All rents are paid to the receivership estate, bills to operate the property are paid by the receiver and the borrow/owner is obligated, at the receiver’s request, to provide the receiver with all leases, plans, permits, environmental reports and other documentation that the receiver deems necessary to properly operate the asset until they are discharged. If the owner/borrower refuses to provide the requested documentation, in most U.S. markets the receiver is authorized in the appointing order to take the requested operating documents with the assistance of local law enforcement. Lenders will often indirectly use the receivership and powers just described, for the purpose of obtaining as much property documentation as possible. What is the typical duration of a receivership? If the property foreclosure completes, in most states the process of an uncontested foreclosure runs between three (Texas has one of the shortest periods, often less than 30-days) to five months. Receiverships are “at-will” and can be terminated at any time (in some cases the threat of a receiver is used as a negotiating tool by the lender and within hours of the receiver’s appointment, the parties agree to a loan work-out and the receivership is terminated). In other cases, it is the desire of the parties (and the court) to keep the receiver in place for an extended time (i.e. if the receiver is to complete the construction and disposition of property during the receivership estate) and so the receivership may remain active for a period of months or years. Because the receivership estate is at-will, all service providers employed by the receiver to effect the proper administration of the receivership must also be at-will. It is fair to say that in most cases a service provider (i.e. a commercial agent) who’s agency agreement (listing) is terminated at the end of a receivership will most likely be hired “back” by the eventual new owner (typically the lender) because they are “in place” and are familiar with the operations and benefits of the property. Therein lies a benefit to agents (brokers) to know and work with receivers is to be put “on the job” which will increase the likelihood that they will be re-hired, post- receivership, by the lender’s REO department but there cannot be an agreement in advance. There are at least three compelling reasons for lenders/plaintiffs and borrowers/defendants (“the parties”) to agree on having the receiver sell the collateral property “during” the receivership. Because the receiver is an agent (or officer) of the court, the property is sold “as is” (no recourse to the buyer unless fraud is involved) and no post—closing claims can be made against the court and/or receiver for environmental contamination, injury or in the case or residential property, construction defect liability (typically ten years). The proceeds on sale are typically the same or more to the lender if the asset is sold during (pre-foreclosure) than after the receivership. The primary difference is that if the lender takes title and then sells, he takes on the liability of future litigation. A broker listing a property for sale with a receiver should remind any prospective buyer that, in most if not all states, the buyer should complete exhaustive due diligence before a purchase because sales from a receivership are without representations, warranties or future rights to claims based upon property condition. During the receivership, the receiver should insure that all health and safety issues are in good order, that insurance is in place, the asset is being properly maintained and that costs to administer the receivership are kept to a minimum. It is important to distinguish between a foreclosure and bankruptcy. If a receivership is in place and the operating entity commences bankruptcy proceedings, all efforts to collect a debt against the debtor in bankruptcy are subject to an automatic stay under federal law. Thereafter, the receivership is subject to the automatic stay3 unless it obtains relief from the stay pursuant to an Order of the bankruptcy court. The Order of relief from the automatic stay is required in order to separate the real property collateral from the bankruptcy estate (which is administered by a trustee) in order for the foreclosure on the collateral to continue (and the lender to receive his proceeds in a timely manner) and to reappoint or to appoint a receiver. What happens to security deposits? This is often bad news for tenants and an area in the law that, in most states, will be a cause of great concern to many tenants. In most states, receivers are not responsible for security deposits if they are not turned over to the receiver and in most cases security deposits are co-mingled with other project funds in the borrower’s property’s cash account, so there is great difficulty in determining if any of the funds transferred to the receivers bank account (in cases where funds are transferred) were in fact, security deposit funds from a specific tenant. The reality is that it is unlikely the owner/borrower/defendant has performed his or her obligations regarding the disposition of the security deposits at the time of the appointing of the receiver. In California, in general, the landlord is to transfer to his successor-in-interest the remaining portion of the security deposit and notify the tenant of the transfer, any claims made against the deposit, the amount of the deposit and the contact information for the successors in interest (see California Civil Code 1950.5). The result being that many tenants occupying properties that have been subject to foreclosure may have to challenge their new landlord (or the initial landlord) for the return of all or a portion of their security deposit. In most cases, I suspect they will not recover those funds. Commercial brokers would be wise to advise their tenant clients of this issue and encourage their clients to see legal counsel on the manner in which they can best protect their pre-paid security deposits. It is not uncommon in receiverships for the tenants to default on their rental payments. It is the receiver’s decision on how to deal with the late-pay of the tenants. In cases where there is little expectation that the tenant will be able to remain current on their rental payments, even if the rent is reduced to the current market rates (typically receivers have the right to modify existing tenant lease terms or execute a new lease for a period of no more than 12 months), the filing of a Notice To Pay or Quit (“Notice”), Summons and Complaint is made. If the receivership is terminated during the Notice process, in most states the Notice can be assigned to the successor-in-interest in the real property. At the end of a receivership estate, the receiver files a final report and accounting and order for the same and the distribution of funds with the court and by court order the bonds are exonerated and estate is terminated. Besides listing property with receivers, commercial practitioners should use receivers to help them identify lender contacts for post-foreclosure listings. Once a lender has foreclosed, he/she has written down the value of the asset to fair market value as determined by appraisal, less expected soft costs (commonly 5-8 percent for legal, marketing, etc.) and is a motivated seller, the ideal kind of client for the commercial broker. The “lenders” of today are the owners, in essence, of real estate. Working with receivers provides an opportunity to lease or sell property in a poor economy, which is something all transaction professionals are looking for. 1 Wei, Lingling, Grant, Peter “Commercial Real Estate Lurks As Next Potential Mortgage Crisis”, Wall Street Journal, August 31, 2009 2 Warren, Robert; Etienne, Joseph; Mitchell, Bruce “Rents and Profits Receiverships, Loyola III, California Receivers Forum, January 17, 2009. 3 Callari, Andrew, Esq., Callari & Summmers, a Law Corporation, Costa Mesa, Calif. |