Cycle Shift Moves Servicing to Center Stage

Jean Yee. Image by SRK Headshot Day

The once overlooked importance of commercial real estate loan servicing has taken on a new level of visibility since global disruptions began in early 2020 with the pandemic, and has continued into the subsequent rate volatility and asset performance shifts during 2023.

Servicing professionals were on the front line of the initial lockdowns, assessing operating impacts and responding to forbearance requests in real-time, while adapting to their own workplace transformations. Servicing departments also became the first to see both the long-term occupancy impacts of post COVID shifts in real estate use and subsequent cash flow disruptions in an era of increasing rates and deteriorating asset values. It is during times like these when the importance of aligning active servicing to successful future outcomes becomes clearly apparent.

Strategic loan servicing will play a critical role in the months ahead as market forces continue to disrupt and impact asset performance. The industry has started to face the challenges of distress, especially with a rapid change in leasing, maturity workouts, and rising defaults in the office sector. Ultimately, in a turbulent market, a strong relationship between borrower, servicer, and lender will be critical in achieving positive outcomes for assets adjusting to these new conditions. For many near-term maturities and struggling assets, servicing professionals will not be able to cure all the ills of a market in transition, but it is important to recognize their role in helping to shape best-case-scenario outcomes.

What’s a borrower to do?

Gantry’s servicing team has experience from the past 30 years of administering loans for our correspondent insurance companies and conduit lenders. In the spirit of sharing best practices, the following are some worthy considerations from our successes working with our lenders and client borrowers.

Communication: The most relevant step a borrower can take when facing distress is to communicate with their servicing representative and do so at the earliest opportunity. Developing a rapport with your servicer during good times through regular contact helps ensure an open line of communication when performance suffers. Don’t embrace a 9-11 mentality. It will clearly be better to collaborate on solutions than hide from realities. Don’t wait for your servicer to discover your distress: proactively engage it with them. All lenders have significantly ramped up their internal portfolio surveillance demands since COVID due to their own regulatory and asset management requirements, so they are built for finding problems long before the payment panic button is deployed by the borrower.

Planning: During that communication period, work with your mortgage banker advisor to make sure you have developed a clear assessment of the challenges a property is facing or will be facing, along with a realistic plan for dealing with the struggle when presenting to the lender. Servicers can make lender recommendations, but ultimately will rely on the borrower to commit to meeting the nuances of loan document obligations and servicing standards set by the industry to realistically execute new terms and meet performance metrics if approved.

Underwriting: When the mortgage banking advisor placing a loan also services that loan, a borrower tends to receive more coordinated insight into the property performance. Commercial mortgage banking requires a dedicated servicing capacity that embraces ongoing underwriting and differs from mortgage brokerage in this key element. A commercial mortgage banking firm uses its servicing experience to place clients in manageable financing arrangements that are structured to benefit the borrower and survive tumultuous times.

Maturities: For properties nearing a maturity that will meet a new rate climate at negative leverage, the discussion on a loan extension needs to start early. Most lenders do not want to assume responsibility for a property in their portfolio and will often try to forgo a default. They might be willing to act as a bridge to a point in the cycle where a property can return to at least cash neutral, or better, performance.

Trust: For Gantry, many of our relationships with both our lenders and sponsors span decades. These relationships provide a superior line of communication, and a vested interest in the outcome of the process. When a borrower has little to no history with a lender or is just sent to a remote call center, the servicer’s perspective becomes very narrow when navigating modifications. Trust from the lender in their underwriting and servicing diligence, and trust from the borrower that the loan will serve to achieve future goals, protect the asset, and ultimately find win-win solutions are critical for achieving strong results.

Conduit/CMBS Lenders: Conduit lenders will have less flexibility in navigating non-performing loans. A sponsor needs to understand that their covenants may ultimately require a default and special servicer to navigate any potential modification or foreclosure. But unlike most lenders, the special servicer may be open to owning the asset to drive fees. Work with your servicing team in advance to ensure that key areas of concern are addressed and that the non-recourse obligations are maintained before a special servicer transfer occurs.

Performance: Be prepared to maximize and optimize. Maximize rent revenues where possible. Optimize your operating costs. Build cash reserves. Impress your servicer and lender with hard work and attention to the fine collateral details. If they see you working toward future success, your capital sources will be pushed to work with you toward a win-win solution. They will ultimately determine that they cannot manage a property’s interest as well as the existing borrower.

Although there are many reports in the press nationally about properties being handed back to the lenders, every property is unique and has its own story to tell locally. Trusted advisors who are third-party experts are more important now than ever to help navigate those challenges and end up closer to an optimal result for the borrower.

Jean Yee is servicing director, Gantry.