The commercial real estate lending market has seen great upheaval in the last several years. Prior to 2020, offices were full on a daily basis, interest rates were low and available space for lease in premium locations was difficult to obtain. Fast forward to 2024, office space continues to empty as companies decrease leased space because of a greater shift to remote work, the Federal Reserve continues to raise or keep steady higher interest rates and availability of space in premium locations continue to rise. As a result, commercial real estate developers and entities involved in commercial real estate are reexamining their outstanding loans to address the changing factors at play in the market. For some, it may be a simple renewal. For others, a close examination of the loan may need to take place before deciding whether to renew the terms of the loan or the terms or economic situation may have changed where a workout needs to take place. What are the factors borrowers need to consider as they approach the loan renewal or workout process?

The Players

Before diving into the particulars of loan renewals and workouts, it is helpful to remember all of the players that are involved in the loan.

• Borrower(s) – This is straightforward. The entity or private individual/individuals who take out the loan.
• Lender – The financial institution delivering the money to the borrower. While seemingly straightforward, determining who exactly the lender is can become more complicated as the loan process goes forward due to institutional transactions and transactions with the loan itself.
• Servicer – Manager of the loan (“servicer”) who collects payments, escrows, etc. Usually a third party in large transactional or (C)MBS deals, but smaller/regional/local lenders will service their own loans.
• Originator – The “lender” or institution that generates (originates) the loan.
• Securitizer (Secondary Market) – Institution that purchases the loan on the secondary marketplace. Well known examples include Fannie Mae and Freddie Mac.

Loan Renewals

When examining their loans to begin the renewal process, the borrower should always start with a review/analysis of the current loan documents. The analysis will highlight the existing terms of the loan and the steps required for a renewal. If a borrower is seeking a renewal, the borrower should pay particular attention to the extension and/or notice deadlines, if there are any, in the terms of the loan because some loans require notice of renewal (and even payment of fees) 30 -180 days prior to the expiration of the loan.

In light of today’s economic market and the Federal Reserve raising interest rates to their highest levels in over 20 years, the loan market has become difficult for new borrowers, but could present itself to be lucrative for the borrower if renewing an existing loan.  For example, if the loan renewal is on a set term with an interest rate of 4% on a $5MM, 20-year amortized loan, but the current market interest rate is 7.5 percent, that could mean a $10,000 per month difference on payments. Over the lifetime of the loan, that could mean an additional $1.7MM in interest costs, on top of the principle of the loan.

For commercial real estate developers or individuals without the option of renewing at a fixed rate, the new, higher interest rate could be detrimental to their business, and a workout on the loan may become necessary.

Workouts

A workout is essentially an agreement between the borrower, lender, or perhaps the servicer, to modify the loan obligations to prevent a default on the loan. General types of workouts commercial real estate borrowers may consider include:

• Forbearance – A temporary workout. Often set for a certain period of time, forbearance may include suspension of payments and/or other loan terms, such as:
  • DSCR (Debt Service Coverage Ratio) triggered events,
  • Lock-box payments to control the cash flow of the business
  • Cash sweeping to use excess cash to pay down debt
• Minor Modification – A temporary workout. Minor modifications are typically payment reductions, i.e., the borrower makes interest only payments for X months. This may also include allowing an outside investor or debt contributions.
• Major modification/restructure – A permanent workout. This involves greatly changing the loan agreement between the borrower and lender or servicer. Examples of major modification/restructure include:
  • Extended amortization
  • Cutting the loan principal (a rare major modification that turns cancelation of debt into taxable income)
  • Recapitalization
  • Additional collateral

Borrowers should be cautious when approaching the workout process. The process can be document/submittal heavy and opens the business up to the possibility of being audited and having its financials certified. The workout process can also be costly. Depending on the depth and scope of the workout, fees/costs of the process can be just as, if not more, expensive than a new loan. Borrowers also need to be cognizant on what they say during the process because admitting payment cannot be made, in newer loans especially, may be a default in and of itself.

Throughout the loan renewal and workout process commercial real estate loan borrowers need to be in regular contact with their legal counsel. A knowledgeable commercial real estate attorney will guide borrowers through the process to ensure the borrower is obtaining the most beneficial type of workout events are not triggered that leads to an immediate default on the loan.