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Playing by the rules in the new restructuring game.

Over the past decade, both Sponsors and Equity Investors alike (hereinafter "Sponsor(s)") of real estate transactions have become accustomed to cheap money and high leverage.

With the availability of free flowing capital, Sponsors could easily justify paying advisors for value-add services.

As a result of the de-leveraging currently occurring in real estate and the lack of "cash out" refinancing, many Sponsors do not have the necessary capital available to pay for the services required in workout and restructuring situations. This is at a time when these services are crucial.

Those Sponsors that assemble an advisory team will have the opportunity to potentially preserve a greater portion of their equity in a less contentious manner.

The advisory team should include at a minimum: experienced legal counsel, tax counsel and a financing advisor who is strategic, who understands the art of negotiation and who can provide services requisite for the transaction at hand. Many Sponsors take the view that they can "go it alone" when faced with a restructuring. However, for the same reasons that a qualified advisor adds value when arranging financing, a qualified advisor will add value to a restructuring beyond the compensation that they receive.

A restructuring can be an emotional experience for Sponsors. They have equity at risk either in the form of cash, imputed equity resulting from value creation, potential tax liabilities and in certain cases personal recourse.

Naturally, Sponsors feel that their transaction should be the most important one, but yet they may be dealing with an existing Lender or Master and/or Special Servicer (hereinafter "Lender(s) and Servicer(s)") who are inundated with technical and maturity defaults. As a result many Sponsors become anxious and exacerbate an already difficult situation.

First and foremost, experienced real estate advisors are able to bring unemotional advice to an emotional situation. They have the ability to provide strategic and objective advice backed by real time market intelligence. When utilizing the services of an established and well-respected advisor, Sponsors are able to take advantage of the credibility that the advisor has already established with existing Lenders and Servicers.

The advisor has a better overall understanding of restructuring issues and outcomes resulting from other such experiences which will benefit Sponsors in formulating a strategy. But perhaps most important, an advisor who understands the art of negotiation will buffer the Sponsor to better preserve their relationship and reputation so that they will not be penalized when "normal" lending activity returns. This subtle factor is one that many inexperienced advisors and Sponsors fail to grasp.

A common mistake that many Sponsors make is to assume that their Lender and Servicer will simply extend their loan or they assume that a write down or discount of the loan can be easily attained. These strategies are fraught with pitfalls, especially in a world where most transactions have capital structures that involve numerous constituency groups engaging in tranche warfare.

Simply being able to get to the right person, understanding the issues inherent in pooling and servicing agreements, co-lender agreements and other governing documents and having an appreciation for tranche warfare are examples of yet more subtleties of the current restructuring environment, requiring the expertise of an advisor who understands the inherent issues.

With more than $625 billion of commercial real estate loans maturing during 2009 and 2010 alone, it is prudent to try to protect equity and refinance the property ahead of the dam of maturities that is building up versus log rolling into the eye of the refinance storm.

For this reason advisors should first attempt to refinance their clients existing loans for an appropriate term that will provide flexibility to ride out the storm and to refinance to a lower cost alternative once the financing markets stabilize.

If the existing loan is either unable to be refinanced or if refinancing proceeds are not enough to take out the existing loan, and joint venture equity capital is not a viable option, then the marketing information gathered during the attempted refinance for the benefit of a restructuring negotiation will be utilized. In some recent transactions, demonstrating a "good faith effort" to refinance a property has been more favorably received by the Lender and Servicer. Yet this is contrary to what many Sponsors do, which is to notify the existing Lender and Servicer upon maturity that the property cannot be refinanced without making any real effort to actually refinance it. This latter strategy is fraught with obvious negative consequences.

Another mistake of many Sponsors, specifically with respect to securitized maturities, is to engage a monoline CMBS advisor (hereinafter "CMBS Advisor") to represent them with the Master and Special Servicers.

More often than not, the CMBS Advisor lacks the breadth of services that a full service advisor, with a proven and long-standing track record will bring to any negotiation.

A qualified full service advisor brings experience in arranging new debt, mezzanine capital and joint venture equity in addition to the ability to represent the Sponsor with the existing Lender and/or Master and Special Servicers.

An advisor's ability to provide services beyond the short term is essential if Sponsors want to maintain control of their equity. When taking on an assignment the goal should be to refinance now entering into a restructuring only if such refinancing is not attainable. To accomplish this goal in a timely and cost effective manner requires a marketing effort to refinance the property while concurrently providing restructuring services.

Due to the on-going nature of these assignments, it is realistic that the advisor will market the property for refinancing both initially and on an on-going basis should the existing loan be extended for a short-term.

At the same time, Sponsors have been accustomed to compensating advisors on a success basis upon transaction consummation. Given the significant amount of work that is involved in a properly formulated restructuring, which should include significant financial modeling, marketing in an attempt to refinance the existing loan and if so required multiple marketing efforts, qualified advisors require minimal compensation. This may be in the form of an up-front retainer, with either on-going monthly fees or varying fixed fees paid for differing outcomes which may include short, moderate and long term extensions, write downs, discounted buy backs and ultimately a refinance either now or in the near term future following any short term extension that may result.

As the end goal of the Sponsor should be to preserve their equity and maintain control of their asset, these restructuring agreements should contemplate ongoing fights for the advisor to refinance the property as the financing markets stabilize.
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Comment:Playing by the rules in the new restructuring game.
Author:Schildkraut, Russell
Publication:Real Estate Weekly
Date:Aug 5, 2009
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