Bringing Lazarus Projects Back to Life
Over the last few months, I have been contacted more and more by developers and property owners who have been settling litigation efforts with a bank, business partner, builder or alternative-financing company that left them holding the bag with unpaid contractors and the inability to create cash flow because the building is incomplete and a certificate of occupancy cannot be obtained.
Some stories are clearly due to regulatory change of winds that would not allow a traditional bank to continue construction draws because re-margining rules required a capital call and they could not recapitalize their project. Others are just plainly egregious, made-for-TV dramas wherein an alternative lender was basically trying to steal the property from under the borrower through sheer brute force or never had the funds in place from the start. They had given them an approval to commence construction or rehabilitation of their property and hid behind complicated language in a contract, hoping they had the larger war chest to fight it in court.
Fortunately, with the attorneys having done their good work of getting the client back into a place of control, now they can focus on doing what they wanted to initially: create both cash flow and return on capital. The most difficult part to ensure the success of a project is to deal with what some therapists call the “death of a dream.” This is especially true after experiencing what may be an elevated feeling following the courts approval to have your loan amount reduced, other liens vacated, and getting to do your victory dance. Now it is time to return to doing fundamental research; updating the sales, sold, for-lease and leased comparables; changing your cap rate from 4 percent to 8.5-10 percent; reducing leverage from 90 percent to between 60 and 70 percent; considering full recourse against your balance sheet; and working with city-council members to have your project revived from the dead hoping you can figure out a reasonable way to renew the permits without spending 10 percent of your new budget in attorneys and fees.
If you are serious about facing the death of your project and making it rise from ashes, be honest with yourself about the realities of the market. Be willing to take a hard look at your spreadsheets, and you will get traction on your proposal. More than half of the projects that are coming across my desk have inflated sales or leasing numbers reminiscent of the 2005-2007 timeframe, and the assumptions in the Argus or Excel model have not been reviewed to reflect the current market.
It is also important to understand that projections are of no value if you cannot back them up with leasing activity that reflects your assumptions. While you may have been able to lease 10,000 square feet of multi-tenant industrial per month in your market before, it might take you three to six times as long now, and your interest reserves should show it. It is also important to understand that using the entire projected net operating income and ignoring what the personal balance sheet looks like is a waste of your time. Painting a clear picture to the lender or equity partner on how you will get to the finish line with a realistic exit strategy is paramount.
Change and flexibility are good. Letting go of old assumptions and dreams can mean the resurrection of your Lazarus project sooner than you think.
Marcelo Bermúdez is the President of Los Angeles-based Figueroa Capital Group, a subsidiary of Charles Dunn Company, that focuses on structuring debt and equity solutions for commercial real estate investment properties.