How flexible are lending institutions when borrowers want to rework their loans? The answer depends on a few key factors, most notably the type of lender - either traditional or conduits - and the loan type.

Lenders have been flooding the real estate market with capital for several years, and the current market is no exception. Even after last fall's correction in the CMBS market, most of the players are now back to business as usual.

The bout of conservative underwriting that immediately followed the turmoil has already given way to the rush to invest the corporate quota of dollars at a solid rate of return.

"Lenders were definitely conservative early in the year," says Charles Krawitz, vice president and regional originations manager with Chicago-based LaSalle Bank N.A. "But any discipline is gone now. Most players feel that if they don't do deals, they are out of the business. As a result, they are much looser on both deal structuring and pricing."

Although the interest rate on 10-year U.S. Treasuries, which is used as a baseline for capital pricing, has been creeping up in recent months, most borrowers and their advisers still view the current cost of capital in favorable terms. The U.S. Treasury 10-year bond yield was listed at 6.1% in early August, up 0.6% since early May.

But in absolute cost the rates are still good deals, says Dan Bryson, senior director and producer with Holliday, Fenoglio, Fowler, a Houston-based lending intermediary.

Weighing the options Real estate owners looking to finance centers need to consider more than just cost when lining up loans. Even with the best planning, unforeseen problems or opportunities may arise during the term of the loan that can either be resolved or capitalized on if the lender has the flexibility to make changes.

The reasons a center owner/borrower may want to rework a mortgage can run the gamut. A request to refinance could stem from the loss of an anchor store, new competition, or even a chance to add a new anchor, explains Steve Graves, senior managing director of Principal Capital Management, a Des Moines, Iowa-based investment adviser.

In the case of a lost anchor, the owner may need additional cash to renovate the center to attract another large anchor, or to reconfigure the space for multiple smaller tenants.

"If you lose a Home Depot, for instance, it's difficult to find a single tenant to fill the space, so you usually have to divide it," says David Moret, vice president with Continental Real Estate Cos., a Miami-based full-service real estate firm.

In-line drugstore spaces are another likely candidate for going dark, Moret says, because of the ever-increasing number of large, freestanding drugstores.

"The 10,800 sq. ft. in-line drug spaces that were so popular 10 years ago are now very awkward to lease in the current market," Moret says. Consequently, these obsolete spaces will probably require new construction to retenant them.

A new competing center may require the owner to upgrade his center's appearance or risk losing market share. Or perhaps an upgrade is what a new anchor requires in order to sign a lease.

Reworking loans for any one of these reasons is done quite often for his firm's general accounts, says Graves.

Direct lenders such as insurance companies and pension funds, which underwrite loans for their own accounts, provide the name of someone the borrower can talk to about reworking the loan, if the need ever arises.

That's not always the case, however, with CMBS loans. "Once they are securitized, it's hard to go back and open up the loan again to make any changes," explains Andrew Oliver, managing director with New York-based Sonnenblick-Goldman Co., a retail lending intermediary.

"It is one of the decisions the borrower faces," says Krawitz, whose firm currently has approximately $1 billion in long-term real estate loans outstanding. "Does the borrower want the flexibility of a direct lender, or does he want the higher loan-to-values and lower prices offered through securitization?"

Pleading their cases Even if the direct lender offers the flexibility to make such a move, the borrower must document why the changes will improve the center's cash flow and strengthen the center in the marketplace.

"We will want to see the new pro forma, the signed leases from the new tenants and construction estimates on the work to be completed," explains Moret. "All of the agreements have to be tied up with the I's dotted and the T's crossed. Also, the borrower wants to deal with a lender he knows and trusts."

Indeed, the relationship is important to both sides in such a transaction. "There is more of a willingness on our part to work with a borrower we have a long-term relationship with," says Krawitz.

"We would rather rework the loan than have the borrowers default on it and destroy any chances of future business with them," he continues. "Besides, with strong clients we know they are good for the money and that the center is well-located and will attract a new anchor or solve whatever the problem may be."

In some cases, rates of return on loans may be lowered to basis-maintenance levels. "This is just what it takes to make the bank whole, to make sure we break even," Krawitz says.

Preferred retail types Relationships aside, lenders are generally risk-averse and prefer to lend on properties that reflect their conservative philosophy. In retail, the most favored property type is the grocery-anchored neighborhood center.

These centers cost less to build than larger retail concepts, and the basic services they provide are less likely to be affected by a down economy. Graves reports that 80% of Principal Capital Management's retail business is with grocery-anchored centers.

Similarly, the lender's willingness to rework a loan is based on the perceived risk, so grocery-anchored properties are likely to receive favorable treatment from the lender.

However, opinions vary, and some finance experts believe that malls are also strong candidates for refinancing.

"As long as the mall is a good, well-positioned property, companies will be willing to refinance them," says Oliver. "The large institutional lenders have experienced almost no delinquencies on their mall portfolios."

Price and quantity Whatever the property type, the willingness to rework the loan and pricing it are two different issues.

"The loan-to-value (LTV) of the original loan may have been 60%," Graves explains. "After the capital is added to the new deal, the LTV may now be 75%. Although it may be a stronger center, our risk has increased. Therefore, we would have to increase the interest rate."

Too many variables are involved to make a general statement about the appropriate level of interest rates in refinancing situations, Graves says, but as a rule the borrower should expect some increase.

What may nix any chance of reworking a mortgage from the outset are pre-payment penalties or yield-maintenance provisions, which can make the cost of obtaining a new loan prohibitive.

While these costs can be waived or reduced at the discretion of the direct lender, in CMBS loans they are written in stone. "With CMBS you have to live by the letter of the document," Krawitz says.

Limitations of CMBS Getting a CMBS loan reworked is difficult but not impossible. However, the nature of the beast does work against such transactions.

"Institutional investors that buy CMBS are not focused on the real estate side," says Tim Mazzetti, vice president of Midland Loan Services, a Kansas City-based CMBS lender. "They are only interested in how long the loan will continue to pay off at the present rate of return."

Moreover, the logistics of redoing a CMBS loan are complicated. Says Graves, "With CMBS we have to take the data on the proposed changes to the center to the trustee of the loan pool, and if the documentation doesn't sway them, then nothing will be done."

Given this mindset on the part of owners of loan securities, Mazzetti characterizes the reworking of CMBS loans as "not impossible, but painful."

To surmount these difficulties, the borrower should engage in some degree of pre-planning. Adding precautionary provisions to the loan documents can give the borrower/owner more leeway if unforseen events do occur.

"A lot of things can be structured on the front end of a CMBS loan," says Mazzetti, whose firm services $32 billion in securitized loans. These provisions do not require that construction be done to the property, but they give the owner that option if he deems it necessary.

For example, structured loan provisions could provide for a partial release of outparcel sites from the limitations of the mortgage commitment. These limitations usually prevent any changes to the property.

The freedom of action provided by the loan provision would allow the borrower/owner to renovate the outparcel sites to accommodate new tenants, and even to receive tenant improvement funds from the lender if so stipulated.

The dollar amounts and the degree of renovation work the owner is allowed to undertake would be stated in the lease provision ahead of time.

"These provisions are written into the mortgage with as many details as possible already agreed upon," Mazzetti says. "The more specifics that are laid out, the easier the process goes."