Reed Law Monthly - November 2009
Property Triage: What to Do When Your Property is Drowning
Over the past year real estate markets have fallen so fast and far that many investors now hold properties that are worth quite a bit less than their outstanding debt balances. With no clear property recovery in sight, what should you do when your property is underwater and drowning?
Recognize that the Lender Now Owns the Property. If the market value of your asset is less than the debt, then your equity is gone - and the lender now "effectively" owns the property. At this point, although you hold title, you are essentially working for the lender. Keep this in mind as you consider your options.
Act Quickly. Doing nothing will not solve the problem, and may actually make the problem worse. In many situations lenders are more than happy to postpone recognition of a problem loan, that way they do not have to recognize the impairment on their books. This "extend & pretend" lender reaction doesn't provide you with a comprehensive or long-term solution. It just serves to delay the inevitable, and wastes both time and resources in the process.
Be Realistic. Accept the fact that in our current economic climate the best you can do might be to achieve a "least worst" solution. This "least worst" solution may enable your company to survive the real estate down-market and position itself to take advantage of an eventual up-market.
Hire Competent and Experienced Counsel. Now is the time to bring in the pros. Attorneys who specialize in real estate can analyze the distressed situation, identify available options, and then formulate and execute an unbiased action plan based on the legal and economic realities of the current situation.
Take a Close Look at Guarantees. Be sure to have your legal advisor analyze any personal or corporate guarantee exposure. Keep in mind that if you do not have personal guarantees, or you do but the "collectability" factor is low, you have more control in a negotiated solution.
Don't Forget Tax Impacts. Depending on the type of (a) debt; (b) borrowing entity and its financial status; (c) workout/restructuring; and (d) foreclosure action (if any), a borrower may have tax impacts related to recognition of cancelation-of-indebtedness (COD) income and capital gain.
Avoid Putting Good Money After Bad (the "Re-Margin" Request). Your lender may push you to put whatever cash you have towards carrying and/or paying down the loan (i.e., THIER secured-debt investment). Careful consideration must be made before committing precious cash to an asset that has "negative" equity.
If the market drop has wiped out your equity you need to act as quickly as possible - but now's not the time to go at it alone. Specialized real estate counsel can help you achieve an acceptable, comprehensive and long-term solution.