IRS Updates Procedure to Make Commercial Loan Modifications More Attainable
Last September, the IRS updated Rev. Proc. 2009-45 which allows for a proactive approach to obtain a commercial loan modification. The updated IRS procedure will benefit distressed commercial properties.
The IRS realizes that owners of commercial real estate will have a harder time refinancing when their loan reaches maturity, due to present tax law regulating pools of commercial mortgages. Because of current market conditions and the tightening of credit, many commercial borrowers won't be able to refinance in the next few years. Even if owners have good cash flow, they still run the risk of default.
To really understand the significance of the IRS change, we need to briefly understand how commercial mortgages are packaged.
Once a loan is issued it becomes a CMBS or Commercial Mortgage-Backed Security which is pooled together with other loans and placed in a REMIC or Real Estate Mortgage Investment Conduits. The purpose of the REMIC is to sell it to Wall Street investors or other investor entities as a securitized asset. PSA's or Pooling and Servicing Agreements define what a Loan Servicer can or cannot do.
When is comes to modifications, the IRS imposed limits on when a modification can be started within a REMIC to avoid tax penalties, usually when a borrower was already in default or near default. Loan Servicers also were hesitant to perform major changes to loans to prevent possible tax penalties. Now the updated IRS procedure allows for a proactive role to prevent commercial loan defaults and still allow REMICs to enjoy their tax favored status.
Under the IRS procedure update, the Loan Servicer must reasonably believe that the borrower is at risk of default at maturity date or earlier. The Servicer must diligently determine from the borrower's "credible, factual written representations" that indeed a loan default is at risk. The good part about this update is that there is no maximum period to determine a loan default risk. This means that if a loan is performing but a year or so down the line the maturity date is due, the Servicer can take reasonable action to head-off a default through a commercial loan modification or workout. Of course market conditions, property values and credit accessibility would play a part in determining default risk.
As more commercial mortgages reach maturity, a good number of properties will have problems refinancing. A good workout plan to extend terms, lower interest rates or defer payments will help many avoid foreclosure.
How to Enhance the Likelihood That Your Commercial Loan Modification Application Will Get Approved
Due to the the economic downtrend, the commercial loan modification is an option that property owners may want to consider if they are having problems coming up with the monthly payments for the commercial mortgages. Some companies that own such real estate properties may also consider asking for an adjustment of the terms of the loan as a way to temporarily reduce their expenses although they may find that it is much more difficult to get the approval of the bank or lender if such is the case. The financial institutions often hesitate to give in to requests for a restructuring of the mortgage because this will severely affect their cash flow estimates.
Banks and other financial companies are in the business of lending money to provide the regular flow of money that they can use again to produce more money, and so on. A commercial loan modification will disrupt this flow so it is only natural that the banks will resist as much as possible. The only way to improve your chances of getting your petition approved is to show that it would be for the best interests of the lending companies to adjust the terms. This will also be true for businesses that want to sell the property through a commercial short sale where the bank will have to consent to the discounted selling price that normally will not be enough to completely pay for the total outstanding debt.
An important strategy that may be taken is to get the services of a commercial loan review expert or professional who has the experience on how to use the best techniques for convincing the banks. One such tactic is to conduct a thorough review of the mortgage documents to find out if the lender had taken any shortcuts that violated certain laws. Studies by experts have revealed that a large percentage of the lenders during the boom period had indeed transgressed certain laws and regulations that have been established by the government to safeguard the rights of borrowers from predatory practices.
When such violations are found in the documents, they may be utilized by the company to strengthen its negotiating power when asking for changes to the terms. This is because such violations if proven to be true can negate the provisions of the mortgage, including foreclosure. In fact, even if the foreclosure proceedings have already been initiated, the court can order that they should be put on hold until the hearings with regards to the violations have been completed. The lender may even be required by the court to reimburse all of the previous payments that have been made. If such violations are found, they can be used in combination with documents showing the bank that the borrower has temporarily lost the ability to make the regular payments. It may also help to prove that the reduction of the amounts or the provision of a grace period for the business to recover until such time that the financial situation has improved and a return to the original amounts may be possible, can be beneficial for both borrower and lender.
Commercial Loan Workout Programs – Ideal Fit For Distressed Properties
In troubled economic times, there have been a lot of newsmakers from Wall Street bailouts to home loan modification programs.
However, one troubled market has slipped under the radar for too long: commercial real estate. According to the Wall Street Journal, real estate prices have dropped by over 43% since a 2007 peak. And foreclosure rates continue to rise.
Unlike the housing market, the term "loan modification" has been slow to catch on with the commercial sector. In fact, it seems many commercial property owners don't even realize they have an option when a property becomes distressed.
The refinance market is dry and with values plummeting, it can seem impossible to get the bank to approve new financing. Many property owners are hearing "no" and simply accepting that as the final answer.
Commercial Debt Restructuring is a Viable Option
When the refinance application comes back denied, that's not the end of your rope. What it means is you need to pursue other options. A loan modification is basically a way to restructure your commercial debt even when no other financing alternatives prove viable.
Making it work ultimately comes down to whether or not you can show your lender a justifiable reason to work something out. And in this case, "justifiable" is really just another word for "financial."
After all, this is a business decision that has to make sense for both parties and in the end, it will come down to your ability to afford payments on the property going forward.
For example, if you're so far upside down that even a modification won't bring you back in line with a realistic income and expense report, the bank is going to say no.
Negotiating With the Bank
You can either negotiate directly with the bank yourself or utilize a third party. Usually, results are easier to come by with a third party due to expertise and relationships. There are certain things the bank wants to see and knowing how to properly present that is crucial.
Your rent roll and income and expense report will basically tell the story, but there are right and wrong ways to do it.
Granted, hiring a third party means there is some expense involved, but the fees they charge can be quickly recouped by the savings you get with the lower monthly payments.
Ultimately, you have to make the decision that gives you the most comfort and assurance.