Last week we looked at the amount of equity that the buyer of a lender-owned distressed property might have to inject at the time of purchase. We follow up this week with another question to be addressed when approaching a new lender for purchase financing on a distressed property: Why will the project and the loan be successful this time around? The answer to the question really starts with an analysis of why the deal failed. In addition to too much debt, here are my top reasons why good deals fail:
Inadequate management: Management issues are probably the single greatest contributor to deals failing to meet projections or maintain value. When a market is hot, just about any management company can fill a property and keep it occupied. As John F. Kennedy said, “A rising tide lifts all boats.” But when a market turns challenging, only the most experienced management companies will keep the property full and running well. Management that does not have the experience or resources to handle market changes can be a death sentence for an otherwise good property.
The solution is to get a management company for the property that has experience in the field. Presenting an impressive management company résumé with turnaround experience and a plan for addressing specific issues to the new lender will significantly improve a buyer’s chances at getting the new loan.
Not enough liquidity: It takes cash to keep a property running efficiently: cash to make repairs when things break, cash to upgrade to keep a property competitive, and so forth. If a property has been overburdened with debt or is being sucked dry by other problem projects, there is simply not enough cash left to make necessary investments in the property and the deal will fail.
The solution is to project reasonable cash needs for the property and show the new lender how these needs will be addressed. Escrows and sinking funds will give the new lender confidence that cash will be available when needed, avoiding the property’s past problems. A loan package to finance the purchase of a distressed property should, at a minimum, address the above issues as well as any other problems that previously plagued the property. The key is to differentiate the current situation from the previous one and clearly evidence how things are or will be different when new management and fresh resources are brought to the table.
(Brian Andrews is a certified mortgage banker specializing in the financing of commercial real estate. His business is Andrews Commercial Real Estate Services and he can be reached at firstname.lastname@example.org.)