As an increasing number of commercial property owners face upcoming debt maturities, more of them have started to use threats of strategic default as a bargaining tool in negotiations with lenders.
Knowing how reluctant lenders are to take back assets, borrowers of every kind, from big publicly traded REITs to private players with only a handful of centers, have tried this gambit, industry insiders say. Whether or not the strategy works depends in large part on the type of lender and the condition of the property.
“Many years ago, a good borrower would avoid using strategic default because then you would have a stigma on your image that may impact your future borrowing power,” says David T. McLain, principal with Palisades Financial LLC, a commercial real estate lending and advisory firm based in Fort Lee, N.J. “What you are seeing now, when the downturn has led to widespread defaults, they are no longer fearful because their belief is that when the economy recovers, this will be overlooked and they will be able to borrow.”
The dramatic drop in the value of retail properties, coupled with the “everybody’s doing it” mentality, has led many borrowers to consider using strategic default as a bargaining tool, says Gerard Mason, executive managing director in the New York City office of Savills LLC, a real estate services provider.
A recent Wall Street Journal story cited primarily large publicly-traded REITs as the culprits, including Simon Property Group, Macerich Co. and Vornado Realty Trust. But private owners, institutional investors and real estate funds are doing the same thing, Mason notes. Most buyers who invested in commercial real estate in the last three to five years are looking at upcoming mortgage maturities and thinking up ways to restructure, he adds.
In some cases, borrowers might not be trying to paint lenders into corners, says McLain. In instances where a loan is part of a CMBS pool, for example, it’s virtually impossible to discuss restructuring until a default has actually occurred. Only after a borrower stops making loan payments can such loans be worked out. In these cases, lenders often discreetly tell borrowers, “You need to default or we can’t do anything.”