By WILLIAM CREELMAN
Whether the current downturn in the real estate industry may end up being the worst we've
experienced since the early 1990s or, as some believe, the worst since the Great Depression, is
not the real issue for builders and developers. The real issue is: What do you do to protect the
future value of your company and position yourself to take advantage of the opportunities that
this type of market environment make possible?
Following are five critical considerations that builders and developers, now facing difficult times,
should be contemplating as part of their business planning efforts, with the intent of embedding
them in their long-term strategies.
1. It's All About the Cash Flow
For the foreseeable future, cash will be king. During times of distress, a company needs liquidity
to be able to survive long enough to negotiate and implement a restructuring with its lenders and
other constituents and/or weather the storm until the market recovers. If a company gets caught
short on cash, even the best-laid plans to restructure or wait out the downturn will be all for
naught, as in today's environment lenders and investors are loathe to provide additional capital
unless it's part of a final implementation of an overall restructuring plan which they deem
acceptable.
We are already seeing homebuilding companies shedding assets and drastically scaling back
operations in order to preserve existing liquidity, reduce the drag on their balance sheets and
allow them to reduce their go-forward overhead expenses in anticipation of having to undertake
a major restructuring and/or wait out a prolonged downturn.
There's an old adage attributed to Napoleon that states "an army marches on its stomach,"
which is to say that a hard-working organism relies on good and plentiful nourishment. Cash
liquidity is the key nourishment that will help keep a company alive while it rights the ship with its
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lenders and other constituents or until better days arrive. In our experience, companies wait too
long to take steps to preserve liquidity and then run out of time before being able to implement a
solution. Simply, don't be caught in this trap - focus on cash flow at the project and/or entity
level, not the income statement.
2. Be Proactive with Your Lenders/Investors
For many companies, the current down market arrived like a tsunami, leaving little time for
preparation. While the dark clouds on the horizon were visible, institutional money was easily
available and times appeared to be good - too good.
Now, here we sit in today's tough environment. Top managers must react to the realities of
today's anemic product demand, financial markets that may be, at least temporarily, inaccessible
as well as plummeting lender collateral values. Many times the lender's loans to the company
are "under water" vis-Ã -vis the collateral values, which just a short time ago adequately
supported the loans. They must prepare and implement business strategies to carry them
through the next three to five years, which will be difficult times. To be sure, management cannot
do this in a vacuum; they must work with their constituents.
Sometimes ego, pride or other obstacles get in the way of sound decision making, unduly
delaying the implementation of operational and/or financial measures necessary to weather the
storm. Reaching out in earnest to lenders and other financial partners is absolutely critical for
survival. They can be your lifeline.
Financial institutions in today's world are extremely selective about which real estate companies
and projects they will back and which ones they cut loose. In this environment, it's important for
a company to be "transparent," that is, be fully visible in all aspects of finance and operations.
Even the hint of corporate sleight of hand can be a big turnoff and word gets around quickly.
Consequently, it's advisable for top management to take the high road when dealing with funding
sources. Be responsive, straightforward, candid, honest and proactive. During difficult times,
solid financial relationships are one of a company's most treasured and valuable assets.
The company should not wait for the lenders to come to them. While lenders in this environment
can become administratively overwhelmed in dealing with their burgeoning volume of problem
credits, they do have a desire to resolve their issues quickly if they can. Being proactive and
bringing a resolution will not only likely result in a higher level of cooperation, it will also allow for
a resolution before the market declines further, when a restructuring will be harder to implement.
To be sure, all of this does not mean that management has to capitulate to the demands of
lenders. It does mean that in order to get all parties to face their significant problems and accept
reasonable restructuring proposals, you must retain credibility and drive the process yourself.
3. Maintain the Viability of Your Platform
During these difficult times, it's not uncommon to see companies switch gears and find new
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markets and opportunities until their core business returns. For example, during the dramatic
downturn of the early 1990s, a number of real estate companies turned their attention to
generating fee income by utilizing their core competencies to become third-party developers/
builders, project consultants and sales/marketing entities. Changing the company's focus can
preserve a company's main platform until its core business returns to health. It is our belief that
smart people and smart companies can survive despite the most daunting circumstances.
If a company's strategy is to make it through the tough times, then it's important to keep as much
of the core management team in place as possible. Terminating a top salesperson or one of the
more creative marketing managers simply because he or she falls below the "do-not-retain" line
might be more damaging than terminating an executive whose responsibilities do not serve a
company's immediate need to survive. Like an athlete competing at the highest levels, those
companies that will survive and ultimately prosper must have the least body fat and the greatest
muscle tone to reach the finish line standing up. A company that is perceived to be smart and
strong, structured to meet the challenges of a down market, will have a much easier time dealing
with the challenges of today's economic doldrums.
It's also important to maintain relationships with key vendors, especially those who are critical to
the continuation of projects. It's all too common a practice for companies to cut fees of planners,
architects, contractors and others without an overall plan in mind as to what the resulting
company will look like and providing an explanation to the affected party. It's an excellent way to
lose top vendors and, consequently, quality work and materials. Reduce fees if necessary and
explain to vendors why it's necessary and commit to them for future work if they commit to you.
4. Implement a Global Solution
Survival during challenging times such as these cannot be accomplished by implementing plans
on a piecemeal basis. Survival is best achieved through more global strategic planning that
encompasses all aspects of a company: its financing, operations, products, markets, customers
and people. That's why a well-developed, reality-based strategic plan with input from several
different viewpoints, areas of expertise, experience and skill sets becomes critical because it
establishes a consensus roadmap and focuses valuable corporate resources.
Many real estate companies have debt at multiple projects from many different lenders or groups
of lenders and all may have different and finite collateral supporting these separate agreements.
Some of these loans may be ultimately in the money, while some may be impaired. Those that
are impaired may be so to varying degrees. In these circumstances, it is critical to negotiate and
implement a global solution for all the lenders at once. This will not be easy because multiple
lenders will have positions and agendas that vary greatly from one another.
The company and its owners likely will have limited additional assets available to put into the
"pot" of a restructure agreement, almost certainly not enough to make everyone whole. While
the temptation can be great to restructure the debt of those lenders that come to the table first,
this would result in the company or owner having nothing left to offer the parties who come to the
table later in the process. At that point, a consensual restructuring with these last parties will be
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much more difficult, if not impossible. It is much better to bring everyone to the table and divide
up the finite amount of remaining value available as part of a restructuring solution among all
parties as part of a global solution. The likelihood of achieving long-term success is much
greater with this approach.
It's also extremely important when formulating the global strategy to look beyond the near-term
horizon to go as far into the future as makes business sense - at least three to five years. It's not
uncommon for companies to hunker down so far they can't see what's ahead in the medium to
long term. Someone needs to be looking ahead - way ahead - and thinking about "what's next."
Assuming the company gets through the worst of the downturn, what should it be doing when its
markets improve? This is when a longer-term strategic plan anointed by top management
becomes an extremely valuable tool. If ever there is a time for "vision," this is it.
5. Remove Cloud of Any Guarantees
An important element of a global solution is the removal of any guarantees. Many business
owners have personally guaranteed the debt of their companies, so if the lenders collect less
than 100 percent of their claim, they can pursue the owners' personal assets to help make up
the difference. Often, there is not enough value in the guarantee to make everyone whole.
Company owners need to have these guarantees eliminated in exchange for consideration that
preserves reasonable value for the guarantor. If the guarantees are not encompassed within a
global solution, it may be extremely hard for an owner to extricate the obligations of the
guarantee without being exposed to potential draconian measures when parties move to
exercise their rights under the guarantees.
Further, unless the cloud of the guarantee is removed, it will likely be a significant distraction for
the owner/guarantor, the chief leader and strategist of the company. It could put the guarantor in
a somewhat conflicted position of having to fight for protection from financial obligations to the
same party who is still the main provider of capital to his company. This untenable situation can't
be good for any of the parties involved, another good reason to have the guarantee resolved as
part of a global resolution.
William Creelman is principal and co-head of corporate finance at XRoads Solutions Group, a
nationwide professional services firm headquartered in New York City. Creelman is based in
Santa Ana.
Wednesday, November 12, 2008
Foreclosure Crisis Solutions
The foreclosure news in Orange County is bad and probably will get worse. More than 1,000 county homes went into foreclosure in May, a record. Chapman University just reported that California’s economy, including Orange County’s, may be in a recession. One reason for this is undoubtedly the housing market collapse. A recent report from the National Association of Mortgage Bankers says that during the first quarter, California homes accounted for 21% of those that went into foreclosure around the country, more than Florida.
California now accounts for 13% of all foreclosures throughout the U.S., a staggering number.
I’ve seen this type of housing crisis before, during the recession of the early 1990s, and it wasn’t pretty. But this is
worse. Much worse. What makes foreclosures this time so devastating is that they continue to affect all homeowners,
not just those who have purchased or refinanced a home during the past several years. Each time a flood of
foreclosures hits the market, it depresses housing values in that market.
The Drum Beat
This constant drum beat of foreclosures and all the economic, social and legal turbulence they bring on our country is
creating as much of a national crisis as any hurricane or earthquake. The Federal Reserve projects that about
450,000 adjustable, high risk loans will “reset” every quarter through the rest of this year.
There will be an ongoing tsunami of resets, and thus foreclosures, next year and the year after through 2011, at
which point the devastation should start to abate, assuming no other monumental economic or international crisis
strikes.
There is a solution, and it’s one the federal government implemented once before with significant positive results: the
Resolution Trust Corp. The RTC was a government-owned asset management company mandated to liquidate
assets (primarily real estate and mortgages) that belonged to savings and loan associations that the Office of Thrift
Supervision had declared insolvent during the savings and loan crisis of the 1980s.
The RTC was created by the Financial Institutions Reform Recovery and Enforcement Act, adopted in 1989. In 1995,
its duties were transferred to the Savings Association Insurance Fund of the Federal Deposit Insurance Corp.
Key to Stability
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From 1989 to mid-1995, the RTC closed or otherwise resolved 747 thrifts with assets of $394 billion. Many believe
the RTC was key in stabilizing our nation’s economy at a time when anything less than decisive federal action could
have resulted in a greater Great Depression.
It’s time for the feds to give serious consideration to RTC II, or what I have dubbed the Housing Recovery Corp. If
they did it in the late 1980s, they can, and must, do it again.
As I envision it, the Housing Recovery Corp. will be a quasi-public entity that will establish housing recovery zones in
the hardest hit geographic areas, such as the Inland Empire.
It’s comparable to the federal government declaring disaster relief to areas such as the Gulf states after Hurricane
Katrina. The difference is, this could be a much bigger disaster across the entire country and the destructive force of
these massive foreclosures could create what I see as areas of economic “pocket depressions.”
Here’s how it works. Once a zone is in place, the Housing Recovery Corp. would purchase the debt of distressed,
owner-occupied homes from the debt holder at a discount. The HRC then would restructure the debt into a two-part
mortgage.
The first part would be a market-rate, performing mortgage that the HRC could sell into the secondary market. The
second would be an interest-free, self-amortizing loan based on a contractual agreement with the homeowner and
held by the HRC.
Let’s say a home in one of the housing recovery zones is on the verge of foreclosure because a young family
purchased their $500,000 dream home with a no down payment, and now they can’t afford the monthly payment.
The HRC would acquire the debt for let’s say $400,000 and then split it into a $250,000 first trust deed and a
$150,000 second trust deed. With this restructured loan, the family now can make the monthly payment.
If they stay in the home for, let’s say, 10 years, the HRC will forgive the second trust deed, allowing the family to
realize equity buildup.
If the family sells the home before the 10-year period, the proceeds after paying off the primary mortgage would go
toward paying down the unamortized portion of the second trust deed.
Win-Win
It’s a win-win. The homeowners would have an economic incentive to stay in their homes. The property values of
surrounding homes would not be as impacted by foreclosures. The banks and other lenders would have a secondary
market for their non-performing mortgages. State and local governments would be relieved of the pain of seeing
residents kicked out of their houses and rentals. (A lot of rentals are homes now in foreclosure with renters standing
in the doorways). The housing market—and ultimately the economy—would not be pummeled by the tidal wave of
foreclosures.
Berger is a principal of XRoads Solutions Group, which has offices in Santa Ana and New York. A workout consultant
during the real estate recession of the early 1990s, he has experience advising distressed homebuilding and other
real estate companies.
California now accounts for 13% of all foreclosures throughout the U.S., a staggering number.
I’ve seen this type of housing crisis before, during the recession of the early 1990s, and it wasn’t pretty. But this is
worse. Much worse. What makes foreclosures this time so devastating is that they continue to affect all homeowners,
not just those who have purchased or refinanced a home during the past several years. Each time a flood of
foreclosures hits the market, it depresses housing values in that market.
The Drum Beat
This constant drum beat of foreclosures and all the economic, social and legal turbulence they bring on our country is
creating as much of a national crisis as any hurricane or earthquake. The Federal Reserve projects that about
450,000 adjustable, high risk loans will “reset” every quarter through the rest of this year.
There will be an ongoing tsunami of resets, and thus foreclosures, next year and the year after through 2011, at
which point the devastation should start to abate, assuming no other monumental economic or international crisis
strikes.
There is a solution, and it’s one the federal government implemented once before with significant positive results: the
Resolution Trust Corp. The RTC was a government-owned asset management company mandated to liquidate
assets (primarily real estate and mortgages) that belonged to savings and loan associations that the Office of Thrift
Supervision had declared insolvent during the savings and loan crisis of the 1980s.
The RTC was created by the Financial Institutions Reform Recovery and Enforcement Act, adopted in 1989. In 1995,
its duties were transferred to the Savings Association Insurance Fund of the Federal Deposit Insurance Corp.
Key to Stability
http://www.ocbj.com/print.asp?aid=72900093.2346897.1656967.6742691.722169.916&aID2=127450 (1 of 3) [7/28/2008 11:00:31 AM]
Orange County Business Journal - Printer Friendly Version
From 1989 to mid-1995, the RTC closed or otherwise resolved 747 thrifts with assets of $394 billion. Many believe
the RTC was key in stabilizing our nation’s economy at a time when anything less than decisive federal action could
have resulted in a greater Great Depression.
It’s time for the feds to give serious consideration to RTC II, or what I have dubbed the Housing Recovery Corp. If
they did it in the late 1980s, they can, and must, do it again.
As I envision it, the Housing Recovery Corp. will be a quasi-public entity that will establish housing recovery zones in
the hardest hit geographic areas, such as the Inland Empire.
It’s comparable to the federal government declaring disaster relief to areas such as the Gulf states after Hurricane
Katrina. The difference is, this could be a much bigger disaster across the entire country and the destructive force of
these massive foreclosures could create what I see as areas of economic “pocket depressions.”
Here’s how it works. Once a zone is in place, the Housing Recovery Corp. would purchase the debt of distressed,
owner-occupied homes from the debt holder at a discount. The HRC then would restructure the debt into a two-part
mortgage.
The first part would be a market-rate, performing mortgage that the HRC could sell into the secondary market. The
second would be an interest-free, self-amortizing loan based on a contractual agreement with the homeowner and
held by the HRC.
Let’s say a home in one of the housing recovery zones is on the verge of foreclosure because a young family
purchased their $500,000 dream home with a no down payment, and now they can’t afford the monthly payment.
The HRC would acquire the debt for let’s say $400,000 and then split it into a $250,000 first trust deed and a
$150,000 second trust deed. With this restructured loan, the family now can make the monthly payment.
If they stay in the home for, let’s say, 10 years, the HRC will forgive the second trust deed, allowing the family to
realize equity buildup.
If the family sells the home before the 10-year period, the proceeds after paying off the primary mortgage would go
toward paying down the unamortized portion of the second trust deed.
Win-Win
It’s a win-win. The homeowners would have an economic incentive to stay in their homes. The property values of
surrounding homes would not be as impacted by foreclosures. The banks and other lenders would have a secondary
market for their non-performing mortgages. State and local governments would be relieved of the pain of seeing
residents kicked out of their houses and rentals. (A lot of rentals are homes now in foreclosure with renters standing
in the doorways). The housing market—and ultimately the economy—would not be pummeled by the tidal wave of
foreclosures.
Berger is a principal of XRoads Solutions Group, which has offices in Santa Ana and New York. A workout consultant
during the real estate recession of the early 1990s, he has experience advising distressed homebuilding and other
real estate companies.
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