Current State of Distressed CRE Lending: Q&A with Polsinelli’s Josh Dill
Commercial real estate is one of the few distressed asset classes within the U.S. economy. Tightening credit availability, still-elevated interest rates, challenging fundamentals. and declining asset valuations have increased uncertainty among investors, who are looking to “buy the bottom” of asset valuations and achieve long-term returns. But what many perceive as distress may, in fact, represent the market’s reality across sectors and bring about an expanding opportunity set for investors.
Josh Dill, real estate finance partner at New York-based global law firm Polsinelli discussed restructuring initiatives in distressed real estate assets and what scenarios are being implemented, the types of loans lenders are making under current conditions, and what he expects in the space in the coming months.
CM: What were your predictions about the CRE markets at the beginning of the year, and what are your thoughts now, given changes in the macroeconomic landscape?
JD: At the start of the year, I expected increased deal flow by mid-year, with more loan originations and property sales as the year progressed. However, the increased deal flow has only really started appearing recently. I think rates came down a little slower than people had hoped, and there was not as much price discovery in the purchase and sale transactions market.
As for now, in the future, it seems like there is starting to be some increased deal activity (particularly after the recent rate cut), but it still feels tenuous, and any sort of macroeconomic shock could slow the momentum. Overall, though, I am cautiously optimistic about continued growth in transaction volume.
CM: With the Federal Reserve’s monetary easing cycle underway, are you observing an increase in restructuring initiatives that pertain to distressed real estate assets? In these scenarios, what strategies are most likely to be implemented?
JD: We have seen an increase in restructuring activity concerning distressed real estate assets over the past few months. I can’t say whether that is partially tied to the monetary easing because rates are still higher than they had been for some time. That said, we are seeing many more workouts and restructuring. As for strategies, they are usually quite fact dependent.
Factors like the borrower’s equity position, the property’s location and value, and the type of lender can all play a part in deciding the optimal workout structure. Anecdotally, in the market, we are seeing a lot of short sales and discounted payoffs, deeds instead of foreclosure, and preferred equity coming into the deal as rescue bridge capital.
CM: What types of loans are lenders making under the current environment for distressed CRE assets?
JD: We are seeing plenty of different loan structures, including most of the usual loans we see on non-distressed assets as well. We see traditional bridge lending, often mezzanine or preferred equity structures, and plenty of A-B note structures. We typically see future funding to get the property’s business plan back on track, often with significant reserves. Lenders seem somewhat cautious about loan-to-value ratios, but some lenders are willing to stretch (of course, with higher interest rates).
CM: What is the most critical advice you would provide to debtors experiencing liquidity issues that may result in distressed debt?
JD: While I usually advise lenders, the best advice I give borrowers is to get in front of issues with your lender sooner rather than later. In this cycle, we have generally seen lenders willing to work with responsible borrowers with sound business plans for the assets. They typically may require some equity infusion, but we see lenders be creative with solutions for good borrowers. If borrowers wait until the last minute until the asset has deteriorated, a lender will most likely be less accommodating.
CM: What are your expectations for litigation activity, restructuring, and distress levels in the upcoming months?
JD: Litigation is a little out of my practice area. Still, the presence of non-recourse carveouts for interfering with remedies in many loans has seemed to discourage borrowers from litigating bad faith claims. Of course, litigation will undoubtedly increase to some extent in any distressed marketplace.
I think we will continue to see distressed loans as many of the loans now coming due were made in a much lower interest rate environment. Many of those loans will be difficult to refinance in the current market. We are seeing more restructuring activity already, and I expect that to continue as lenders and borrowers work together to restructure some of the distressed loans, especially those with solid sponsorship and sound business plans moving forward.
