Commercial Real Estate Recapitalization and Restructures

Wednesday, March 7, 2012

Presented by: Jay N. Rollins

JCR Capital www.jcrcapital.com

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How did we get here?

• Too much debt in the system

• Too complicated of capital structures

• A “sell the risk” mentality

− This caused:

• Artificially high prices

• Created a bubble

And now….

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The Deleveraging Process

• It’s long

• It’s painful

• It’s here for awhile

Deleveraging of Middle Market Commercial Real Estate

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Over $1.7 Trillion commercial loans maturing over the next five years Not enough capital to refinance existing loans

Source: Foresight Analytics & Commercial Mortgage Alert

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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

$ Bi

llion

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Banks Maturities CMBS Maturities Life Company Maturities Other Maturities CMBS Issuance

OPPORTUNITY

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The New Game in Town

• Intellectual capital is back

• Real equity is needed

• The market is filled with distress sells

• But sellers have different “capitulation” time line

• Government artificially propped up finance system

• Result – A long, slow, road back to normalcy

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What Drives Asset Values Today?

• Rev Par ? • NOI ? • Price per foot ? • Appraisals ? • Replacement Costs ? • Markets ? • Revenue Streams ?

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Answer: Leveraged Return on Equity

Leveraged ROE: Old vs. New

Interest Costs: First: $8MM @ 5% = $400,000 Mezz1: $1MM @ 9% = $ 90,000 Mezz2: $500K @ 13% =$ 65,000 Total Interest: $555,000 Cash Flow: NOI $650,000 Cost ($555,000) Net Cash Flow $95,000 Leveraged ROE: $95,000 / $500,000 = 19%

Equity 96-100%

$500,000

Equity 71-100%

$3,000,000

Interest Costs: First: $7MM @ 6%= $420,000 Cash Flow: NOI $650,000 Cost ($420,000) Net Cash Flow $230,000 Leveraged ROE: $230,000 / $3,000,000 = 8%

Mezzanine 2 91-95%

$500,000

First Trust 0-70%

$7,000,000

Mezzanine 1 81-90%

$1,000,000 First Trust

0-80%

$8,000,000

OLD

NOI: $650,000

NEW

NOI: $650,000 Price: $10 Million Price: $10 Million

Real Estate Valuation & Investor’s Return on Equity

Old New Adjustments required for new Adjustments if cash Summary Cap Stack Cap Stack capital stack to meet old returns flow declines 15%

Price $10MM $10MM $7MM (price decline: 30%) $6 MM (40% decline)

NOI $650K $650K $650K (cap rate 9.3%) $550,000 (cap rate 6.5%) (cap rate 6.5%) (cap rate 9.2%)

Leverage 95% 70% 70% 70%

Leveraged ROE 19% 8% 17% 16.6%

Summary: Change in leverage takes property value down 30% Change in leverage and 15% cash flow decline takes property valu e down 40%

*Both changes are based on cap rates moving from 6.5 to 9.2%.

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Now What • Your situation or how you take advantage of the

situation depends on:

1. Your lenders health • Small banks can’t take discounts

• CMBS does not restructure small loans

2. Your balance sheet

3. Ability to attract fresh capital

4. Your willingness to stay in the game

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Two Types of Restructures

• Work with existing lenders and bring fresh capital

• Buy the note at a discount with fresh capital

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What’s Best for You?

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The Total Strategy Approach

Understand the options at every level of the deal. Think in terms of these three buckets: • Asset level issues: Property performance • Debt issues: Service debt/maturity/lender issues • Equity issues: Putting more equity into the transaction

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Getting to Your Best Outcome

1. Ask the qualifying questions (see the list on next page) 2. Get the necessary information (core asset & financial

info) 3. Solve for the asset metrics (property level

performance) 4. Solve for the debt metrics (debt performance) 5. Solve for the equity metrics (equity performance) 6. Create a strategy

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The Four Qualifying Questions The Four Questions For Every Deal: 1. Senior Debt: “What is the status of the senior debt?”

Anyone with senior debt coming due in the next 3-5 years has issues

2. Mezzanine Debt: If you have mezzanine debt coming due,

it’s most likely a problem 3. Equity Partners: Are your equity partners committed to the

deal and do they have the ability or willingness to put in more capital?

4. What is going on at the asset level – NOI, deferred

maintenance, etc.

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10 Strategic Alternatives for

Owners of Distressed Real Estate

1. Negotiate extension with lender 2. Negotiate a discounted payoff with lender:

• New debt • New equity

3. Refinance the senior debt 4. Restructure the senior debt 5. Refinance the junior debt 6. Restructure the junior debt

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10 Strategic Alternatives for

Owners of Distressed Real Estate

7. Sell the asset 8. Sell the asset with carry back:

• Sponsor carry back • Bank carry back • Hope certificate

9. Bring in new equity partners • Into the partnership • Buy the note at a discount

10. Bankrupt the property: Restructure via the courts

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Workout Alternative and Solutions for Projects Facing Maturing Defaults

Working with the existing lender • Different types of Lender

− Life Company: Easiest to work with − Bank: Understand your bank’s health. Holding out for the banks

failure − CMBS: Size matters. Hardest to predict − Credit Company: Relatively easy to work with

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Workout Alternative and Solutions for Projects Facing Maturing Defaults

To pay interest or not to pay interest – Great Debate: If you want a restructure – you don’t pay

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Working with the Existing Lender

• Come with an “ask”, i.e. know what you want • Be prepared for:

− More equity − Higher rates − Shorter terms − More collateral − Recourse − Confirmation of no lender liability

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Working with the Existing Lender • What you want −More time −Lower interest rates, some forgiveness

• What the bank wants −A Performing Loan −A Non-classified Loan

• Things to think about − Looking forward, what will make this non-classified loan − Is the lender looking to solve a problem or looking for

revenge?

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Working with the Existing Lender

• Most workouts want fresh money • Evaluate your position • Ask about priority of new money. Should come out

before: −Default interest −Penalties −Old Equity

• Maybe new money Pari Passu with loan or a portion of the new money is Pari Passu

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Working With the Existing Lender and New Capital

•Fresh capital – Where does it go in the structure?

1. Fresh capital is very suspect in coming into an existing lender relationship

2. Existing “new term” is key – cannot be short term

− Interest rate: New money will want a fixed rate so it can have more predicatable cash flow

3. Most new money wants to come out first, or at least Pari Passu, but not always available

4. New money and short term extensions – recipe for disaster

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Working with New Capital Providers

• Who is not providing rescue capital − Traditional Banks

• Who is providing rescue capital − Funds (JCR Capital) − Private money

• Key factors to keep in mind − Rate − Fees − Prepayment Penalties − Debt vs. Equity

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Working with New Capital

• Typical “Ask” of Fresh Capital − Bank is accepting a discount − Borrower is bringing fresh capital − Borrower has a business plan with defined exit strategy − Typical Borrower ask

• Can I get rid of you and bring in more traditional capital? • Credit for old equity • Fees • Splits

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Working with New Capital -The New Waterfall-

Preferred Equity Capital 80% Sponsor 20%

Waterfalls Capital: Return of principle Capital: 12% preferred return Sponsor: Return of principle Sponsor: Preferred return of 12% Profit splits 50/50

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Working with New Capital The Pari Passu Equity waterfall

Capital 80% Sponsor 20%

Money back Pari Passu Promote Sponsor Capital 0-12% 0% 100% 12-20% 20% 80% 21-25% 25% 75% 30+% 40% 60%

Note: Lots of variation in these waterfalls. Key Drivers:

• Asset quality • Co-investment • Market • Existing cash flow

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Working with New Capital

The difference between a debt deal and a participating debt deal on recapitalization is the amount of co-investment 30-40% co-invest = Debt: Rate: 8-12% Fees: 1-3 Term: 1-3 year Other Variables:

− Pre-payment penalties − Recourse

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Working With New Capital

• Re-establishing the business plan Nothing brings the sponsor more credit like a well thought out business plan − Acquisition – capital structure − Hold Period:

• Improvement budget • Cash flow proforma • Key things to get the business plan done

− Exit Strategy: • Timing • Lease up assumption – how do occupancy rates compare to current market • Cap Rate assumptions – How do they compare to current market?

− Key Point: Lower the basis and pass that savings along to new tenants, create higher occupancy, stabilize the cash flow

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Making the Best Decision for Each Asset

•The three keys of restructures

The Asset: Current occupancy and rate Potential occupancy and rate Real NOI & Value

The Debt: Lenders Motivation to work with you

The Equity: New commitment from the sponsor Fresh capital – Where is it in the capital and how does it relate to old capital

Key Conclusion: Will you have a low enough new basis to compete in the market?

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Conclusion and Summary

• Extend and pretend is over • Capital providers looking to shed legacy assets • Restructures are possible, but highly lender

dependent • Most restructures require fresh capital • Basic options:

1. Work with existing lender and bring fresh capital 2. Buy the note of a discount with a new capital provider

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About JCR Capital JCR Capital is a Denver based alternative fund manager who provides capital for middle market commercial real estate transactions.

JCR Capital provides the following financial products: • Lower-leverage/lower-priced “classic” bridge loans (rates start at 6.5%) • Higher-leverage/structured debt products • Mezzanine debt • Preferred equity • Equity

JCR Capital Provides Funding For: • New Acquisitions • Recapitalizations • Note purchases (performing and non-performing; including note pools) • Borrower discounted payoffs • Loan restructures • Acquisition lines both debt and equity • Special situations

Deal Size: $2 million to $20 million

The JCR Management team has over 20 years experience in middle market commercial real estate, over which they have invested approximately $1.8 billion in over 275 transactions. 1225 17th Street, Suite 1850, Denver, Colorado, 80202 ● Phone 303-531-0202 ● www.jcrcapital.com