Not so long ago, the market for both new condos and condo conversions was sizzling. Fueled by a booming real estate market, investors built sleek new residential structures and transformed thousands of aging apartment buildings into stylish condominiums.
Considering the current real estate slump, however, it is not surprising that the public's appetite for condos, as well as ‘freshened up’ apartments – better known as condo conversions – has declined dramatically. And as a result, increasing numbers of developers of condos and condo conversion projects are now defaulting on their loans.
This rapid downslide in construction and conversion of residential, multifamily and condominium projects has left many lenders and servicers in a difficult position as many developers default on loans for partially completed jobs.
In fact, many lenders are in a quandary: When a developer defaults on its loan, should it be allowed to continue to work on the project, or should a new developer be brought in?
For many reasons, the developer that has defaulted – or will be defaulting – on the loan is often still the most qualified source for completing the project. For example, the existing developer knows the job, the contractors involved, the materials and sources utilized, and the project's work history and track record – all crucial to its efficient completion.
Bringing in another developer or contractor, even of equal or superior skill, can be time-consuming and ultimately very costly.
So, if the original developer is retained, how can risk be managed? One option is a limited receivership. The use of a limited receivership can be an effective way to continue construction with minimal interruption, while also providing reassurance to the lender that the project is under the control of a competent third-party fiduciary.
It is important to remember that the receiver is not an agent for the lender, but an independent third party hired to protect the property and prevent it from being damaged or seeing its value diminished. A limited receivership is not a specific legal remedy, but is simply a modified receivership that allows the receiver to take a more limited role as long as certain requirements are met, such as staying within budget and on schedule, as well as using funding only for specified items.
In short, under these circumstances, the lender no longer funds the developer directly, but provides the funds to the receiver, who in turn reviews and approves all the developer's monetary requests and directly pays all vendors and suppliers.
This arrangement allows the existing contractor and/or developer to continue its work unhindered, while providing the lender with a third-party watchdog to safeguard spending.
The conditions as specified by the Order Appointing Receiver will differ from the typical scenario in that the receiver's authority is limited unless and until certain specified actions or events occur, such as a default by the developer on one of the requirements included in the order. In such cases, the receiver can exercise greater control over the project.
Because the change in level of authority and the triggering events are already outlined in the Order Appointing Receiver, the transition is seamless and immediate. The most likely sequence is to switch from a limited to a normal receivership, where the receiver takes full possession of the property.
Ultimately, this limited receivership acts as somewhat of a forbearance, but with substantially more control built in.
In a typical forbearance, the lender has limited control over subcontractors and vendors due to lender liability issues. The receiver can remain in place until completion of construction, or even until the last unit is sold, depending on the lender's preference, and the lender can still proceed with its foreclosure.
Because the receiver's ultimate aim is to do what is in the best interest of the property, a limited receivership can give the lender all of the benefits of a forbearance agreement with the added comfort of more control, stability and flexibility.
William Hoffman is president and founder of Trigild, a San Diego-based company specializing in maximizing recovery on nonperforming commercial loans. Hoffman has over 30 years' experience as an attorney and can be contacted at (858) 720-6700.