In Part I of our series, we discussed the current market trends, new legislation and imminent reality of another potential real estate/hospitality down cycle, though not as severe as in 2008. With new and unseasoned players in the real estate market, it is helpful to showcase the common themes we tend to see when working with distressed situations and how each can drastically change the outcome for all sides.

Common Themes Associated With Distressed Real Estate Situations

Managing Egos. Many successful real estate principals have large egos, often believing that they can solve all problems through force of will. Advisers should be cognizant of the importance of managing the ego of their clients. Most seasoned real estate principals will remember the last cycle, but younger real estate clients (who may have been in junior positions during the bust) could be problematic.

Unjustified optimism. Thinking that a real estate or hospitality recovery is just around the corner is a risky and dangerous turnaround plan. The same personality characteristic that led many entrepreneurs to their greatest business successes can equally lead to their biggest losses.

Not being proactive. Doing nothing and waiting for the market to fix the problems is a sure-fire strategy for financial difficulty. Delaying a restructuring often erodes the cash position which will ultimately be needed to facilitate a real solution.

Wasting time, money and effort negotiating short-term fixes. Forbearance agreements can be counter-productive. They can often result in certain of the debtor's legal rights being negotiated away, with very little of long-term value in return. This time, money and effort should be better spent on negotiating a long-term global solution.

Putting good money after bad. The lenders will often strongly suggest that debtors commit additional cash to support their loans. In some instances, this is the right thing to do. But, if the “real” market value of the encumbered assets is less than the debt basis (and is likely to remain so) then the lender essentially becomes the equity holder.

When negotiating with multiple lenders, debtors should only agree to a global resolution. Under no circumstances should a debtor put new cash, or pledge additional collateral without gaining a global restructuring solution.

Issues on which clients may need to be educated.

• While expensive, retaining appropriate legal and financial advisers will send an important message to creditors.
• Restructuring requires a certain mind-set that is often counter-intuitive to an entrepreneur. Principals will frequently want to paint a rosy picture to keep their lenders at bay. This can often exacerbate the problem and waste precious time.
• Professionals who do this full-time have a better sense of what terms lenders will or will not accept.
• Advisers can insulate their clients from unpleasant discussions so that they might be able to do business with these same lenders in the future.
• While a Chapter 11 filing is always an option, the threat of a filing can be an important catalyst to negotiating an acceptable resolution for all parties. Funds that would be utilized to fund a bankruptcy can often be used to restructure an acceptable settlement for all parties.
• Providing the lender with a plan, properly packaged (with appropriate analysis and documentation), will greatly improve the debtor's credibility and thus chances of approval/success. Principals frequently want to rush into discussions without proper preparation.
• Clients must be reminded that long-term relationships with lenders may mean very little to the lenders. Lenders will generally do what they believe is in their own economic self-interest.
• Principals rarely understand that new outside debt or equity will be difficult to raise without a balance sheet reflecting assets at realistic sustainable values. Without a restructured balance sheet, chasing “pie in the sky” capital can be a waste of time and money.

Principals should always act in an honest and ethical manner to maintain credibility with lenders. In our experience, no matter how contentious negotiations get, there is minimal long-term consequences with the lending community for forthright debtors and their advisers.

Impact of Structure and Type of Lenders

The first step is assisting the client to determine what leverage, if any, they may have with their lenders. Restructuring strategies will often be dramatically different depending on the structure (including guaranties) and make-up of the debt provider. Situations with multiple assets, and/or multiple and common guarantors provide the client the most leverage. As more fully discussed in Part III of our series, lenders may become averse to each other, and the debtor becomes a third-party observer.

Single asset situations with either a single lender or CMBS financing provide fewer creative opportunities for creating leverage. An exception is with hospitality situations that more closely resemble operating companies that utilize real estate. The role of management and the importance of the hotel brand can create unique dynamics. In this scenario, the threat of a chapter 11 filing, assuming it doesn't trigger “bad-boy” guaranties, may help the debtor's negotiating position.

In Part III, we will discuss guarantees and their impact on a successful restructuring.

Troy Taylor is president and Paul Rubin is managing director of the Algon Group, a financial advisory firm that provides restructuring and M&A services. The Algon team has successfully handled many high profile and complex real estate and hospitality restructurings in South Florida including those that came about from the 2008 Great Recession. They can be reached at [email protected] and [email protected] or www.algongroup.com.