When Capital Calls, What Will You Do?
- Sep 21, 2011
Telling a partner that a capital call is necessary to keep a property afloat is a recurring dilemma we are seeing frequently. These calls are needed to avoid loan-covenant violations due to revised appraisal values or to add to reserves and cover expected TI’s or capital expenditures because of vacancy/lease expirations.
Aside from trying to save your balance sheet if it is a recourse loan, how do you decide to keep the ownership stake, dilute your equity, sell it, or file for bankruptcy to stave off a foreclosure for a few months?
The first step is to understand value. What’s it really worth? Reviewing your appraisal from the height of the market, say 2006, and the most recent one required by a bank, may show a world of hurt. With values down as much as 40 percent, it is important to understand what the banks and appraisers will review. The income approach will look at in-place rents and will compare that against the market approach to see how you are faring with recent lease and sales comparables. For an investor, this can be confusing. The borrower won’t get credit for a tenant who may be over market in their lease, nor potential pro-forma income if they are under market. When vacancies are filled, these tenants need to be seasoned for at least three to six months before they can actually be counted for value and debt service, especially if there are rent abatements (free rent) in place.
Filing bankruptcy through your L.L.C. can be a negotiating tactic with a lender, but not always foolproof. Loans that were written in the 2005-2007 range may contain “springing” recourse guarantees – basically, a trigger provision for full recourse to an individual if you choose to file. On the flip side, if a borrower’s net worth is substantially tied to the value of the property, he/she may be in a stronger position to negotiate since there is nothing for the bank to attach to aside from the property. Don’t wait until the last minute to make a decision. Work with your attorney early in the process and keep the lines of communication open with your lender, even if they aren’t the most responsive.
Convincing your investors or partners to throw what may seem like good money after bad will require a solid plan to nurse a property back to health. Putting together a realistic time horizon to get vacancies filled is critical to understand when a first, and possibly, second or third call will be required to ensure you can cover potential costs in the future. When pitching this to investors, your position may be diluted, but you get to live another day while values recover.