Working With Owners vs Working Against Owners
Many owners took an aggressive approach to underwriting and debt over the last few years and are feeling the stress of lower NOI and demanding lenders. Adding to this pressure are investors who are not getting the outcomes they expected. Sensing blood in the water, large operators are circling to pick up a discount at the expense of owners and their investors. As a recent situation showed, some fresh capital and management can turn things around for all stakeholders if they work together.
TG Advisory was recently approached with regards to a six-asset portfolio in a major Sunbelt market. It had been purchased during 2021 and 2022 with high LTVs and floating rate debt protected by rate caps. As the rate caps were approaching their expiry, the existing owner realized that it would not be possible to acquire new rate caps, refinance the properties, or bring sufficient fresh capital to retain ownership.
The owner approached TG Advisory with its Support Capital & Management Program to bring sufficient fresh capital and first-class management to the portfolio. It sought a runway of 36 months to give new management time to turn around operations and obtain new financing. Owners, original investors, lenders, new equity, and management needed to be aligned so each party could feel confident making the compromises necessary to pave a path forward.
Engaging Partners to Undertake Due Diligence
It was apparent that the quality and location of these assets made them attractive real estate that would constitute a good long-term hold for any group able to manage them out of their current situation. TG Advisory engaged one of its major country-wide management partners to be the co-sponsor on the project. After a deep dive into the financials and an on-site visit by a 6-person DD team, a plan emerged. Each property needed to restructure their in-place debt before rate caps expired and each had varying degrees of operational challenges.
Approaching the Lenders with Strength
The first step was to restructure the loans with lenders who faced the real prospect of not receiving their full loan back if the properties were foreclosed and sold. This was due to a combination of aggressive LTV on the loan, change in asset prices and non-performance. The offer of new equity and the strength of our management partner encouraged the lender to begin negotiations. The ask on each property was slightly different. For the best property, the only request was waiver of the annual debt-service coverage ratio (DSCR) test. For other properties, the request expanded to capping interest repayments at the NOI with any additional interest due being deferred for several years.
Several properties were valued at significantly less than the debt. For these properties, negotiations centered around subordinating a portion of the debt until a fair return had been delivered to the providers of new equity. In one case, a portion of the debt had to be written off completely.
Finding a Fair Capital Outcome for all Investors
The next step was to address the capital structure. With the GP and LPs facing the total loss of their equity, they appreciated that fresh equity providers did not seek any current return for the first three years and a fair mid-teen return after that. This highlighted the long-term, patient approach of TG Advisory’s capital.
After a capital event, the proceeds were to be split between the existing owner, existing LP investors and the fresh equity providers. The objective was that, upon reaching a fair value (neutral case) in the investment timeframe (5 to 7 years), the lender, owner, and initial investors would have their investment returned. If the best-case was realized, the new and older investors would make a positive return.
By bringing fresh capital and management at a time of distress, both the lender and existing investors took a flexible approach. They agreed to a scenario that incentivized the new investors while protecting their interests.
“When all parties compromise, the outcome is far better than when they take a combative path,” explained Naftali Tilson of TG Advisory. “That is the benefit of our Support Capital & Management Program. By showing faith in the assets, long-term thinking and by bringing patient capital, TG Advisory was able to create a more positive outcome for all parties.”