Photo Credit: Randy Pollack
Bob Schultz and Jim Weigel have been through tough housing markets and lived to tell about it. They used to work for banks, doing loan workouts with builders. Now, they’re helping builders renegotiate loans with their lenders. They know that by the time a loan gets to the workout stage, the best case scenario is that both parties will walk away bloodied, but still standing.
“No one will get their money back,” says Schultz, president of the Boca Raton, Fla.–based sales training firm Bob Schultz and the New Home Specialists. “It’s all about minimizing losses.”
Builders can attempt to renegotiate terms with their existing lenders or pursue new sources of financing. In either case, it’s vital to have a business plan that shows the lender why it makes sense for him to stay in the deal, says Weigel, a consultant with Littleton, Colo.–based Lee Evans Group. Offer realistic market projections and project details, including land, lot, and house prices and sales velocity. And be upfront about what you can—or can’t—add to the pot. Lenders will ask for as much cash down and collateral as possible, Weigel says. “If it can be shown there’s little collateral or net worth to get at, they’ll tend to be a little more flexible.”
What they really want to know is how much of their money they can get back and how fast, compared to foreclosing. “If six months and 80 percent is the best they can get, the bank can figure it out,” Weigel says.
But before a builder talks to his banker, he needs to talk to his lawyer and accountant about his legal rights and obligations, how to protect his assets, and whether bankruptcy is the best option available.
Surprisingly, many builders don’t even try to talk to their lenders when they’re faced with foreclosure.
“For some reason, most builders will never do this stuff,” Weigel says. “They think, ‘I’m just going to go to work and do what I do everyday,’ look at the forecasts and say, ‘Oh well, things are going to get better this year,’ and that’s their plan.”
Battle Plan
Some builders have better plans. Four of them—two that worked with their banks and two that found private money—shared their strategies with Builder.
Sean Batcheler’s Streamline Homes was doing well in the Palm Beach County and Port St. Lucie, Fla., markets. When the market began to turn, he asked for help.
“We were in one of the biggest-inventory, fastest-declining markets in the country. I got together with [my consultants] and said, ‘I need a plan of attack.’”
The plan was to finish the houses in progress—the majority of Streamline’s portfolio was 65 percent completed—and slash prices to get them sold. To do that, he had to convince his suppliers and trade contractors to take 50 cents on the dollar of what Streamline owed them for work completed. Given the alternative—the loans going into foreclosure, and getting nothing—they agreed.
Batcheler went to his lenders armed with contracts from 110 vendors and trade contractors who agreed to the terms, including a lien waiver for the banks. He had estimated the value of his business to the bank and with the help of Schultz, his sales consultant, had a script for what to say. It went something like this: “I’ve been a good customer for many years. I want to be a good customer again. Are you open to working with me over the next several months?”
He asked the banks to reduce his interest rate, put some interest payments on hold, and continue to fund his projects. The bank would pay the vendors the remaining 50 percent owed and then 100 percent going forward to finish the work.
Two of the four lenders agreed. The banks held the interest on the loans and collected it at closing. “We got a lot of our contractors paid and about 60 percent of the portfolio cleaned out,” Batcheler says.
The other two lenders foreclosed. Batcheler’s only option was to file for personal bankruptcy. He’s currently working as the facilities manager for a resort while rebuilding his finances. “I’ve learned that it’s not always going to be a good day in the building market,” he says. “You have to attack things quick and have a good solid plan before the banks are even going to talk to you.”
He also makes a strong point for working with local banks. Much like local builders, they have more flexibility in setting their terms and can react quickly to changing market conditions. “When you’re in your presentation, you need to be at the table with people who can make a decision right then,” he says.
Eliminate Emotion
Stuart Kaye knowingly nods in agreement with Batcheler’s statement. The president of Kaye Homes in Naples, Fla., has loans with five lenders.
“One in particular is very large,” he says. “They’re much more difficult to work with. We’re a speck on their behind in terms of the amount we owe them.”
The best time to talk to your bank, Kaye says, is before you’re out of compliance. “We got in their faces before they got to us,” Kaye says, “and said, ‘We’ve got some issues. We’ll be out of compliance with our covenants in a couple of places, and we want you to know what’s going on.’”
The builder showed its banks a plan that included shifting from the severely depressed under-$500,000 market to high-end construction and renovation. It had a strong financial footing with significant reserves, very little speculative business, and a lean land position. It was able to renegotiate its interest rate, make interest pay-ments, and move forward.
Kaye Homes hit the wall, though, with inventory it never intended to carry. With the freefall in the Southwest Florida housing market, dozens of its buyers cancelled contracts. “We found ourselves going from carrying one or two spec houses to having nearly 50, which is not fun,” Kaye says. The builder reduced overhead by more than 50 percent and cut headcount. It wasn’t enough. Last November, “we saw it would not be wise for us to continue to pay interest,” Kaye says.
Before notifying the banks, the company put together intricate plans for selling the inventory homes. “You need to adjust and adjust and make it a science,” Kaye says. “Get the emotion out of it until the houses are gone, or you’ll get eaten alive, as many builders have.”
The lenders have continued to work with Kaye Homes, he says, because he maintains close communication with them.
“As long as we can make them understand we’re working a lot harder to sell inventory than they could,” he says, “they’re willing to listen.”
Private Pipeline
Mark Braunsdorf says that, in a way, he’s glad that his company, Compass Homes of Columbus, Ohio, couldn’t find favorable terms from banks to front him the money for lots. Not only did it keep him from getting into trouble with holding costs, it forced him to look for private equity funding.
“I went to all the people I knew who might have money and asked, ‘Who do you know?’” A Realtor introduced him to a private equity lender who provides him with subordinate financing on an as-needed basis.
“For a small company, it’s very much a personal relationship,” Braunsdorf says. “He got to know me, and he trusts me. We pay between 5 percent and 8 percent more than we pay the bank for the subordinate financing. It seems high, but it’s a small amount and I don’t have to give away any part of my company.”
Plus, his private equity lender prefers to have the interest accrue instead of receiving monthly payments. “That helps our cash flow,” Braunsdorf says. “I’m not writing checks each month.”
He’s used the money to buy lots for cash, to reduce his risk on construction loans, and to fill in gaps when lenders have changed the terms on a deal. Earlier this year, he had buyers who had given him a $45,000 down payment on a $525,000 house, but the deal was contingent on the sale of their house in Seattle. The bank balked at the contingency and said they needed another $100,000 to write the construction loan.
“Fortunately, I have this private equity funding source,” Braunsdorf says. “He said, ‘No problem.’ That will cost me about another $3,500 in interest, so it’s about three-quarters of a percent of the sale price that I’m knocking off my margin. But I kept the deal, it kept me strong, and kept me moving. That’s where private equity has helped. It gives me speed and access to cash. … It’s invaluable. It’s money we didn’t have. Small builders don’t think there’s anything out there—but there are individuals out there with money to invest.”
Brokering A Deal
VSL Communities, a luxury builder-developer based in Conyers, Ga., found itself essentially locked out of conventional lending with the change in the housing market.
“Traditional sources of funds have dried up,” says Samuel W. Taylor, managing member of VSL. “They’re following a set of rules that comes down from corporate. Common sense isn’t being allowed to be factored into the process. It’s difficult to get funding for building and especially for development. Lenders will acknowledge they can’t or don’t feel comfortable establishing a value point for land and houses.”
The company wound up using a mortgage broker, Sterling and Rhodes, to find private money lenders to refinance their property and provide working capital to keep the project moving forward.
To find the right fit between builder and private lender, Taylor and his broker, Akpo Igherighe, principal of Sterling and Rhodes, put together a one-page executive summary that synthesized VSL’s position and the strengths and challenges of the proposal.
“The key in all this is for borrowers to understand their needs, look through the options, and find a lender that matches,” Taylor says. “It’s one of the reasons I like alternative financing. You start with a blank slate and determine how you want to put it together. That flexibility is really good.”
The flexibility can manifest itself in a host of non-traditional ways. For instance, in VSL’s deal, Taylor came in asking for refinancing for his property loan and cash for marketing. Instead, the lender suggested establishing a budget for marketing that it would pay for directly.
“The marketing was critical to getting the property sold,” Igherighe says. “This way, they knew the marketing was getting done. It was a reasonable business control.”
The infusion of cash helped VSL finish all the landscaping, a critical element for marketing its high-end community and something it would be tough to convince a bank to finance.
“Traditional lenders are just nowhere near this,” Igherighe says. “They have many more regulations to contend with. Private and hard money lenders are more entrepreneurial and flexible. They push the envelope in many ways. … The money is always out there. It just may not be at the bank you’re at right now.”
Seven Steps to Working With Lenders
If you’re in danger of defaulting on a loan, or need new sources of cash, here are seven steps to help you succeed:
Make the first move. The more proactive you are and the earlier you approach your lenders, the more options will be available to work out a deal.
Have a plan. Assemble your attorney, your accountant, and your head of marketing to create a plan to present to your lenders on how you will move the business forward.
Know your rights and obligations. Review loan documents with your attorney for clauses that can help your negotiating position. Your biggest leverage may be the time and money it would take to foreclose.
Connect with the decision-makers. Time is an enemy; you want to present your plan to the people who can make a decision quickly, not someone who has to pass it along to a committee in another state.
Get rid of the emotion. Don’t be stubborn about cutting prices or cutting staff. You must show the lenders you’re serious about reducing costs and increasing cash flow.
Provide constant updates. The more communication with your lenders, the better. Keep them informed of your progress or when you change strategies.
Pursue alternative financing. If traditional financing dries up or banks won’t renegotiate, consider private lenders, who can be more flexible and creative in structuring deals.