By David McCain and Bill Albers, MPKA, LLC
(This is the fourth in a series on what builders need to know about restructuring debt and planning for surviving financial adversity in today’s real estate market.)
You have made the decision to hire a debt restructure specialist, and the process begins.
From the time you hire a debt restructure specialist to the time you reach a settlement can take as little as 60 days or as long as a year, but the process is typically completed within three to six months. The following case studies were performed within this time frame.
Case Study — Great Reputation Builder
A builder on the east coast of Florida for more than 20 years and the winner of numerous awards, Great Rep had three active but stalled communities and was facing $62 million of debt, all personally guaranteed by Founder.
Great Rep bought and developed its own land, and built, marketed and sold its own product. Like many small to mid-size builders, Founder spent 20 years rolling nearly all of his profits from completed deals into new deals. When MPKA met Founder, $18 million of accumulated profits, his life savings, had been used as equity seed capital for Great Rep’s three current communities. Unfortunately, while Great Rep, Founder and the banks were focusing on ways to extend each of the three loans supporting the three communities, none of them were addressing the real issue, which was that all of the communities were severely underwater, with the loan amounts far exceeding the property values.
At this stage, with the loans in default and discussions at an impasse, MPKA was engaged by Great Rep and Founder to negotiate with Great Rep’s banks. Following are case studies involving these negotiations.
- Loan One was comprised of more than 150 finished single-family lots and 20 completed inventory homes. Great Rep owed approximately $14 million on the lots and another $10 million on unsold inventory homes and models. The bank’s release prices were $100,000 per lot and $525,000 per home. The total debt on Loan One was over $24 million and Great Rep had invested $6 million of equity in support of the development. This luxury product was well conceived and constructed. Seventy homes had been completed and delivered, but the project was completely stalled, with the inventory homes the result of cancelled contracts.
MPKA coordinated a structured transaction that allowed Great Rep to liquidate inventory, continue operations, avoid a large deficiency and recoup a portion of its original project equity. First, MPKA negotiated a deeply discounted debt purchase on the lot note using capital from newly found Financial Partner. The $14 million debt was purchased for $4 million. Additionally, as a prerequisite to the loan sale, Financial Partner purchased Founder’s guarantee. It next agreed to waive any potential deficiency claim against Founder and released him from any future guarantee going forward. In addition, by structuring the sale as a note purchase instead of a property short sale, Great Rep potentially avoided phantom income debt forgiveness of nearly $13 million and tax obligations of more than $4 million.
To dispose of the inventory, MPKA partnered with an auction company and sold all 20 homes on an absolute basis tendering all proceeds net of closing costs to the bank in total satisfaction of the $10 million inventory note. Lessons learned from Great Rep’s largely unsuccessful attempt to auction off the properties a few months earlier helped bring the superior results. Only four homes were sold in the first auction, at an average price of $240,000. In the auction of the remaining 20 homes, the average price exceeded $310,000. In addition, despite the challenges of the ongoing credit crisis, MPKA leveraged its mortgage lending relationships and expertise to arrange for a consumer mortgage lending company to pre-approve the community and finance purchases at the auction.
Great Rep was allowed by Financial Partner to continue to market, sell and build homes on the purchased lots as a fee builder. In addition, Great Rep was given a profit participation position after specified return hurdles to Financial Partner.
- Loan Two was originally for a $27 million development comprised of 60 single-family lots and 21 boat slips on the intercoastal waterway, with the anticipated construction of homes valued between $900,000 and $3 million. It took three years just to obtain the boat slip permits. The loan was comprised of $21 million in acquisition and development debt and approximately $6 million of Founder’s equity. Less than 5% of the final infrastructure work needed to be completed — in 90 days at an estimated cost of about $1 million. With the evaporation of the local market and personal capital, Great Rep found itself unable to make its loan payments, at which point the bank stopped funding construction. The loan went into default, construction was halted and the bank initiated foreclosure. MPKA coordinated a structured transaction that allowed Great Rep to continue operations, avoid a deficiency and have an opportunity to recoup equity and earn a fee.
First, although the bank had received two recent appraisals of the property greater than $17 million, MPKA knew it was under regulatory pressure to liquidate assets and got it to accept a discounted note purchase price of $10 million. On behalf of Founder, MPKA also negotiated a release of the guarantee and deficiency claim with Financial Partner, the note purchaser. By structuring the transaction as a note purchase instead of a short sale, Great Rep was able to avoid $11 million of debt forgiveness phantom income and a tax obligation of $4 million.
Great Rep remained in the deal, completed the infrastructure with capital from Financial Partner, marketed the lots for sale and received a management fee and profit participation from Financial Partner.
- Loan Three was for a $23 million development comprised of 85 luxury town homes just blocks from the Atlantic Ocean in a beautifully revitalized pedestrian urban infill location. While all of the site work and pads were finished, only one seven-unit building was completed and only two units were sold. Original selling prices ranged from $500,000 to $875,000. The remaining construction loan was $17 million, and Founder had invested $6 million. MPKA negotiated a transaction that allowed Great Rep to continue operations, avoid a deficiency and earn fees.
MPKA convinced the bank to accept $8 million on a discounted note purchase. Two current bank appraisals valued the collateral at $15 million in its partially completed state, but MPKA convinced the bank that the appraisal was far too high because it overestimated the units’ market absorption and their ultimate selling prices. As part of the transaction, MPKA was able to negotiate the elimination of any potential deficiency against Founder by structuring the deal as a note purchase instead of a short sale. As a result, Great Rep avoided phantom income debt forgiveness of $9 million and $3 million in taxes. In addition, MPKA was able to secure a commitment from a third-party lender to provide a construction revolver to build out the remaining town home units despite the constrained credit market. As with its two other deals, Great Rep remained engaged as a fee manager with a profit participation.
Case Study — Direct Equity, Debt Restructure and Tax Incentives
The developer of active adult communities in central Florida for nearly 100 years, Fourth Generation Builder had five active communities with slowing sales volume. None of Fourth Gen’s $25 million in project debt was guaranteed. In addition, Fourth Gen’s bank had issued a short-term debt — secured by Fourth Gen’s profit sharing plan — of $18 million.
At the recommendation of its lender, Fourth Gen engaged MPKA to restructure its debt, raise capital and review expenses just 14 days before the end of the company’s fiscal year. About to run out of cash within 90 days, Fourth Gen needed a survival plan that would provide more than $10 million. After reviewing Fourth Gen’s balance sheet, assets, operations and expenses, MPKA provided a solution that provided in excess of $17 million of savings, cost reductions and capital.
In Fourth Gen’s largest community, it owned 150 finished single-family lots and another 450 entitled lots. The finished lots had book value of $8 million, or $55,000 per lot. Of the few sales it had, Fourth Gen was able to sell home buyers finished lots on which it would build within two years for between $80,000 and $150,000. Fourth Gen’s bank had loaned $5 million, or $35,000 per finished lot. The loan was performing. MPKA convinced the bank to write down the loan to $2.9 million, or $20,000 per lot, and then accept a deed in lieu of foreclosure from Fourth Gen. As a result, Fourth Gen was able to show a capital loss of $2.2 million and consequently recapture $1 million in previously paid taxes under FAS 109 rules. The bank did not want to own the lots and was facing its own fiscal year-end 30 days later, which made it a highly motivated seller. Within those 30 days, MPKA negotiated the purchase of the lots at the written down value and it subsequently marketed them, several of which were available to Fourth Gen on an escalating option basis.
This survival plan enabled Fourth Gen to stay in business in its original ownership for two more years. However, the debt burden of the company’s profit sharing plan and land loans ultimately became too great. Accordingly, MPKA brought in a new set of investors who purchased most of the remaining assets, assumed the liabilities for the homes under construction and the employee costs, and restarted Fourth Gen under a capital structure that has allowed it to continue to build profitably to this day.
The final article in this series will discuss potential moderating factors within the confines of the debt restructuring arena and review some of the lessons that have been learned.
David McCain and Bill Albers are the principals of MPKA, LLC. They have successfully restructured more than $1 billion worth of home builder and developer debt over the last 24 months. They can be reached at [email protected], 305-439-7051, and [email protected], 214-219-1288, or by visiting www.mpka.com
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