Property & the Law
Carl F. Schwartz
Plan for a Crisis Before One Hits
At times like this, the old Boy Scout motto—“Be Prepared”— comes to my mind and should come to the
minds of all players in the New York condominium
market.
It’s no secret that at least two markets crucial to condo development here have slowed considerably: the transactional
market from which New Yorkers buy units and
the debt-and-equity finance markets that fuel development.
We who have been in the local real estate game
for some time have seen this before. The lesson
we learned, or should have learned, from earlier
down markets is one for the ages: when the music
stops, it’s too late to dance. Be prepared. Anticipate crisis. The players—condo developers, their
lenders, bankers, investors, accountants and yes,
their attorneys—should huddle before crisis hits.
Failure to do so will eliminate options that may
have existed with better planning.
It is possible to mitigate the harsh effects of a
down market. Some development projects that
were originally conceived as condominiums will
become pure rentals. Some will become hybrids,
where owner-occupied units will co-exist with unsold units that are, at least for now, rentals.
Confounding some developers’ responses to
the current slowdown is mezzanine debt—prevalent lately but
relatively absent from earlier sluggish markets. The existence of
mezzanine debt adds another confusing layer to the question of
whether a condo project facing distress should or even can convert to rental.
There are many questions to consider, and these are but a few
of them: Does the offering plan permit the developer to rent
units rather than sell them? Do the terms of the construction
and mezzanine loans permit the developer to do so? If the mezzanine lender declares a default under its loan, will that trigger
a default under the mortgage? What effect will loan defaults or
a decision to rent rather than sell have on purchasers who are already under contract or have closed? How will the attorney general’s office react in those circumstances? What intercreditor
issues will exist among the holders of different levels of debt,
and how will they be resolved? What will a mezzanine lender’s
rights and obligations be under an existing offering plan if the
lender becomes the owner of the sponsor after a default under
the mezzanine loan?
When restructuring a condo project, the more layers that
exist—developer, sponsor, senior and junior mortgage lenders,
mezzanine lender and buyers under contract or who have
closed on units—the more imperative it is to keep open lines of
communication and bring to bear good will and creativity early
in the process. Prospering or at least minimizing pain in a market downturn can be achieved if all parties remain focused on the objective, but the chances
for a successful outcome increase greatly only if
planning is early and action is swift. Again, get
out in front of your problem, whether it is a
condo project not materializing the way you penciled it out or a loan that is backed by diminished
collateral.
Besides swift and early action, flexibility is another attribute that will stand real estate professionals in good stead in uncertain times. Avoid
becoming psychologically stuck on the notion of
what the project was supposed to be, particularly
if it was conceived during a more robust market.
Finally, there is no time like the present to
make new partnerships, renew old but dormant
relationships and generally take steps to increase
market share. Take lending and finance, as one
example. During the go-go years, insurance companies were out of favor as lenders. Now, though
their capacity for lending is less than the asset-backed lenders’
capacities were, insurers are a source of possible financing. Borrowers who kept those relationships alive when the insurance
companies were less relevant are now positioned to enjoy the
fruits of those efforts.
Specific legal advice can and should be dispensed only by attorneys to their clients, but I believe that the above is generally
sound counsel. So gather your professionals, plan ahead, be flexible and make and revive relationships. Some day—very soon, we all
hope—the current doldrums will be but a distant memory. —RENY
It is possible to
mitigate the
harsh effects of
a down market.
The views expressed in this article are those of the author and not Real
Estate New York.
Carl F. Schwartz is partner and chair of the real estate department at Herrick, Feinstein LLP and a member of Real Estate
New York’s editorial advisory board. He can be reached at
cschwartz@herrick.com or (212) 592-1416.
