Real Estate Receiverships and Choosing the Best Partner

Real Estate Receiverships – Choosing the Best Partner

By Jay Kelley, Managing Director, Focus Management Group, Tampa, Fla.

The downturn in the commercial real estate market has had a severe impact on lenders, investors and developers alike.  According to the Federal Reserve, default rates on commercial real estate loans skyrocketed to 8.79% at the end of the second quarter of 2010, up from a low point of 1.02% in 2Q 2006.  These levels of default have not been seen since the early 1990’s.  Commercial real estate (“CRE”) values have plummeted almost 45% from their peaks in 3Q 2007.  Liquidity has all but evaporated and with the stall of job growth and household formation, a rebound in CRE markets may be many years off.

With this as a backdrop, many lenders are faced with the decision of how best to manage their troubled CRE portfolios.  Alternatives under consideration often begin with restructuring loans with existing ownership. However, the short-lived era of “amend, extend and pretend” with existing borrowers is quickly coming to a close as pressure from bank stockholders and regulators continues to mount. Once a lender has concluded that it needs to foreclose on a property, the appointment of a receiver is generally the best first step.   However, the receiver appointment process is often misunderstood.  As a result, even though receiverships can be a lower cost – higher return alternative, lenders are often uncomfortable traveling down that path.

Receivers are independent third parties, who are appointed to preserve and protect the underlying collateral assets with respect to a lender’s defaulted loan.  Receivers are appointed by the court and operate under a specific receivership order.  In CRE situations, the receiver has all the responsibilities of a property owner/manager and is tasked with overseeing an appropriate level of care for the collateral asset.

This article will discuss real estate work out situations from the viewpoint of utilizing a receiver – offering examples of successful methods and approaches.

Utilizing the Receiver Approach

If a lender has determined that foreclosure is necessary, a receivership offers a bridge between the current state of disarray and the eventual foreclosure.  The receiver operates under court guidance to preserve and protect the assets – including real property – that serve as collateral for a defaulted loan.  In many CRE cases, projects may be partially completed, vacant, experiencing significant levels of deferred maintenance, or severely under-managed.   Relationships between the lender and the borrower are stressed.  The receiver is an independent third party whose only interest is the preservation and protection of the asset for the benefit of all creditors.

A receivership is generally less costly than a bankruptcy, while still providing court oversight.  In most states, the lender is able to impact the decision regarding selection of the receiver and assist in the crafting of the Receivership Order.  The importance of the Receivership Order is paramount:

  • It can be used to define specific reporting requirements, such as cash flow budget development, budget reporting, monthly financial statement reporting, etc.
  • If renovation, build out or construction services are needed, the Order specifies proper procedures and reporting requirements to accomplish these tasks.
  • The Order can also be used to define security positions for any new money invested in the project by the lender, in much the same way a DIP (“Debtor In Possession”) loan provider receives priority and protection through DIP orders in bankruptcy.

In CRE situations, the timely deployment of a receiver can minimize the cost of either completing a partially built project or managing a completed project, while working to protect the current value of the asset. The receiver’s third-party status can usually neutralize the difficulties parties may have been experiencing in their efforts to reach compromise positions to allow the project in question to move forward.  In addition, this approach can reduce the lender’s exposure to potential lender liability claims surrounding decisions to fund or not to fund, how to complete the project, etc.  The receiver’s role is to preserve and protect the value of the asset, and the receiver’s decisions are separate from any decisions that a lender may adopt.

Choosing a Receiver

Lenders are bombarded with an array of individuals and entities promoting their skill in the real estate development and management process.  In addition, many lenders may have a Rolodex full of contacts in various real estate positions.  These potential resources usually fall into the category of developer, property manager, or broker.  Each of these parties bring important insights and skill sets to a project; however, in a receivership situation, the lender is best served by utilizing an experienced receiver with specific experience in real estate development, management and oversight.  Let’s explore why.

In a typical CRE project managed by a receiver, the issues can often be complex, confusing, and confrontational.  The role of a receiver in a real estate transaction is similar to that of a general contractor on a construction project.  A successful receiver organizes and manages the professionals needed to handle the specific issues that a project might require.  These could include accounting and bookkeeping services, management operators, architects and engineers, construction trades, leasing and marketing servicers and legal professionals.  Utilizing a party skilled in one aspect, but with limited experience in other areas, can often have a negative impact on the project, resulting in a deterioration of the asset’s value.  To illustrate this point, consider the following analogy. If you are building a house, you do not hire a roofer or a plumber to manage the home construction process – while such subcontractors are an integral part of the process, the general contractor manages all of the varied subcontractors and delivers a successful outcome – a completed home.

A commercial real estate project, irrespective of size, can be complex from an organization and management perspective.  For example, a professional property manager may be skilled at maintaining rent rolls and managing routine property upkeep; however, a management company may have limited development expertise.  A real estate developer may have the vision to develop the property and handle stabilization in a typical business environment, but may not be experienced in troubled financial situations and economic down turns.

As a lender is faced with the decision of how to best reduce risk for each individual project, the opportunity to employ a receiver with development, stabilization, management AND financial turnaround experience is critical to successfully maximizing value of a troubled project.  Receivers are individuals who are appointed by the court to preserve and protect the underlying value of the specified real estate asset.  While an individual is appointed as the receiver, the bench strength and experience of the firm behind that individual is just as important to achieving a successful outcome.  Bonding ability, and experience in court reporting, are other significant considerations for a lender to think about when selecting a receiver.

Successful Partners

The following example highlights the issues and decisions a receiver confronts and the skills the receiver will need to employ.  Recently, our firm was appointed as receiver for a two-building development project in the southeast.  One building was approximately 80% completed while the second building was estimated to be 90% completed.  Both buildings had been vacant for over twelve months and had interior portions exposed to the weather throughout that time period.  Vagrants had moved into one of the buildings, and the lot area surrounding the buildings was used as a garbage dump by other parties.  The relationship between the borrower and the lender had been extremely contentious.  The lender had funded over $10 million, and the project needed at least $2 million more to finish construction and receive a certificate of occupancy.

During the first month as a receiver, we accomplished a number of critical tasks in a triage mode including:

  • We fully secured the site by removing vagrants with assistance from law enforcement, re-keyed all locks, and protected the interior of the building from the outside elements;
  • We installed a secure fence surrounding the property;
  • We worked with local law enforcement to increase patrols in the area;
  • We immediately established a relationship with the municipality’s permitting office and began the process of updating expiring permits;
  • We engaged professionals to assess the status of the buildings’ functional elements, including structural, electrical, HVAC and plumbing systems;
  • We performed a market overview of the surrounding area to determine current highest and best use of the asset in the context of current realities;
  • We began the process of re-assessing costs to complete the buildings;
  • We seized the remaining bank accounts of the borrower as instructed in the Receiver Order; and
  • We reported all findings in an orderly fashion to the court within specified time periods.

In short order, we prepared a realistic “game plan” for the asset including a detailed cash flow projection that was filed with the court.  Once the plan was approved, we began implementing the plan.  In this case, our view of the asset clearly aided the lender in its decisions relative to its loan work out strategy. The lender made the decision to sell the note to a third party buyer as a result of the progress to completion and stability that the receiver created.  As a result, the lender’s recovery was significantly higher than it had originally projected.

Being an Effective Receiver in the Real Estate World

In addition to comprehensive knowledge of all aspects of real estate, lenders should seek the following attributes in receivers:

  • Disinterested third party,
  • Knowledge of receivership law,
  • Experience dealing with litigious situations,
  • A track record of complying with reporting requirements of the court,
  • Knowledge of accounting controls to ensure cash is being reported and managed properly and accurately, and
  • The capacity to provide adequate bonding.

In the case of real estate projects, a successful receiver needs to act as the quarterback, leading a team of experienced professionals in a variety of disciplines.  Receivers should be capable of:

  • Bringing together the professional resources appropriate to the specific asset in question,
  • Overseeing the court reporting processes, and
  • Developing and executing strategies necessary to preserve and protect the underlying value of the asset while staying completely independent.

An experienced receiver will provide a lender with an optimal recovery outcome.

In Conclusion,

The use of a receiver provides a court-appointed third party approach to real estate work out situations.  It protects lenders from potential lender liability but does not involve the cost struture of a bankruptcy.  Successful receivers must have experience dealing in difficult situations from a financial perspective, an operating perspective and an interpersonal perspective. Turnaround professionals are uniquely qualified for this role, and those with specific experience in the real estate sector should be sought out by lenders.  A receiver can directly improve the outcome of a real estate workout while minimizing the overall management cost to the lender.

First steps to implementing the receiver approach involve developing the draft Receivership Order.  This Order will govern the receivership process and is critical to providing the lender with regular reporting, security protections, and insight into the project.  While the receiver is an independent third party during the receivership process, the receiver is tasked with maximizing the value of the asset – which works to improve the return to the secured lenders.

About the Author

Jay Kelley serves as the Managing Director of Focus Management Group’s Real Estate Practice, specializing in real estate restructuring as well as turnaround and rescue plans for businesses with financial difficulties.  He currently serves as the court-appointed receiver for a variety of real estate properties.

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Real Estate Receiverships – Choosing the Best Partner

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