Times have changed and with it so have the rules of engagement in the real estate industry. No longer will originators who gave developers all the money they needed at little cost rule the industry; in fact, they may soon find themselves out of a job. Developers with poor implementation skills will no longer get bailed out by ever increasing market prices or rescued by the next more aggressive lender to finance their over runs because they are not out there. With the market in turmoil and numerous projects in trouble, high-ranking executives will now get intimately acquainted with their asset managers.
Long overlooked in the past decade when a developer could do no wrong, asset managers are now the most important part of the firm, and the best strategy for an owner, to get their money back.
Thankfully, sanity seems to have returned to the real estate industry. Before a more rationale market takes over, the industry must focus on completing what’s in the pipeline and moving that product. Therefore, developers must face the reality, and lenders and investors must be ready to step in.
This period will require asset managers to rise to the occasion. And rise they must, out of their office and into the battlefield. If you’re an asset manager who has had to deal with the complexities of a weak market or you’re an undercapitalized developer with a project in mid-construction here are a few tips:
- Re-underwrite the deal
Go back to the original underwriting. Know what the original break even and completion dates are, and know the sources and uses of capital. If you have supplemental collateral or are depending on a guarantee, check it all out as diligently as your primary asset. Values and balance sheets change. When dealing with approved land be sure that those approvals have been maintained and can be assigned to you. Developer’s balance sheets are eroding rapidly, so know what they look like now and how they derived value.
Whether you know it or not, if you’re an investor in real estate and/or an asset manager, you’re in a battle. If you treat it as such no doubt you’ll survive and prosper. In a battle, those who treat it like business as usual won’t be as lucky.
- Do a balance to complete analysis
No doubt you will find that there were hard cost overruns, schedule delays and absorption is slower than expected. This will result in more capital being needed and will lead you to know how much. Look carefully at your soft costs. Scheduling delays and slower absorption lead to more interest and carry more money for advertising and sales. Meet your contractors and subcontractors, know all the issues to get your job to a Certificate of Occupancy, fully warranted and punch listed. Impute all hard and soft costs on a spread sheet to show all expenses by month to get to your total cost. Superimpose on the top line a reasonable expectation of absorption and sales, this will adjust your interest and carry to correct expectations.
- Understand the problems
Like a private detective, talk and meet with everybody. Information is power, but direct relationships with those who have the information make you extremely powerful. At midpoint in a project everyone is battle scared, show that you care, that you are there to help and you need them. Do that and they’ll perform for you. Speak to all the people, not just executives, including laborers, mechanics, sales people, architects and engineers. Don’t forget your plumbers and electricians, because without them you’ll never get a Certificate of Occupancy.
If you are mezzanine or equity, do not count on the senior lender to monitor the project. They rarely re-underwrite and often overlook soft costs. If your senior loan is a construction loan, get on that lender’s inspection schedule and build a rapport with their inspecting engineers. These situations require the senior lender to be as diligent as you would be. In the event the senior lender over-funds, realize that your project, collateral and overall basis will be compromised. Remember you’re the one giving them credit support.
- Find out where the money is coming from
If you are a mezzanine or equity investor and your developer/operating partner cannot put up money, it now becomes your responsibility. However, when providing additional capital remember you need ball control. This is your last shot at recouping your investment, so your money must be spent wisely. Developers, even with a gun to their head, don’t easily relinquish control. And keep in mind, if you take control, you must be properly prepared and staffed. Taking over and building out projects will be a reality for many mezzanine lenders and equity players to recoup all or part of their investment.
Be prepared to defend your position and be aggressive in utilizing your loan documents and operating agreements. Go legal early and hard. You can always slow down or stop the process, but remember to always keep talking to your borrower and touching him/her. The more you interface with them the better the chances of coming to a resolution. This approach is far quicker and less costly than the judicial system. Also, keep in mind the developer/operating partner you are fighting with probably has other fights as well. Ongoing lien and litigation searches will reveal this. You need to know who the other suits are with and determine how they help or hurt you. Who is your friend and who is your enemy? The old adage, “my enemy’s enemy is my friend,” is not always applicable.
Know the status of your borrower’s/partner’s other projects and what their status is and who their lenders are. The other old adage, “information is power,” is never more appropriate than in a restructuring.
- Whether you’re mezzanine lender, or equity, make friends with the construction lender.
Construction lenders are rarely as diligent as mezz lenders for good reasons. It’s the mezz lender that gives them credit support. They often rely solely on their consulting expenses for construction progress payments, so get on their schedule and get copies of their reports. Enlighten them to “balance to complete” issues. You both need each other to get out of this, so if you’re a construction lender, work with the mezz guys to make them your friend, not your enemy.
- The wild card–sales or lack there of
Comb the market regularly, because it changes every week. Your developer, most likely, is not pricing right or giving enough incentives. Velocity is key. Hold out for bigger dollars in case interests carry, as well as for security, advertising and sales overhead. Don’t be greedy, move product. Make sure you have a healthy enough advertising budget and are working with a good ad agency and public relations firm. Know your sales force. Evaluate them and make sure they are the right people, and give the right presentation.
- Morale is part of asset management
Another key thing you are responsible for is morale. Morale is a huge issue. By the time you get to this point everybody’s battle is scarred and worn out. You must be able to instill confidence in your troops that you can lead them to the “Promised Land” (and get them paid with their dignity and reputations in tact).
In general, good asset management, particularly in restructuring, requires you to be on the ground face-to-face with the people who are going to get your money back. Remember you are not doing any work yourself and are depending on them. Touch them, engage them, feed them, humanize the relationship and it will reap significant rewards. One thing though, while you are not doing any of the work, you are making all the critical decisions and controlling the checkbook. You must be intimate with your asset. It lives, breathes, changes, and will suck you dry if you are not timely and informed. Remember every day is urgent. Don’t under staff either, you’ll pay for it later, internally you must be able to handle key disciplines including cash management, construction/approval supervision, and marketing supervision.
The key to surviving in a climate like this is to be armed with information, both current and historical, about your project or land parcel. Make sure you know the documents and use them aggressively, touch and see everyone and everything involved with your investment, including adjacent markets. In addition, know everything about your borrower and partner, make a lot of friends on site, be decisive, and take the pain once to re-budget and reschedule balance to completion. One final tip, be accurate–it’s key.
Finish your building/approvals, promote like P.T. Barnum, but lead like General Patton.
William Procida is principal and CEO of Palisades Financial. The views expressed in this article are the author’s own.