Definition: A modification to terms of a commercial loan that does not include refinancing. Modification occurs on a case-by-case basis when the borrower is unable to make loan payments due to financial distress.

What Does This Mean For The Investor?

Commercial loan modification can be an excellent option for the struggling real estate investor. When a property’s value is lower than the market value, it’s easy to get underwater rather quickly. And selling is not always an option, especially when the local market is contracting.

If you are experiencing cash flow problems or having difficulty leasing space to cover the note or can’t sell your property, it’s worth contacting the lender about the modifying your commercial loan.

If you are not knowledgeable enough to negotiate a modification yourself, consider hiring someone who is. Many companies and individuals specialize in working with lenders to modify loan terms. And according to the rules set forth by the FTC, you do not have to pay a fee unless you are satisfied with the renegotiated terms.

When Investors Can Help with Loan Modifications

Are you already familiar with commercial loan modification? Maybe you’ve had some past experience renegotiating a loan. If so, consider offering your modification services to struggling borrowers. You can work on the project as a consultant and collect a fee for negotiating with the lender. Be sure you are very familiar with the FTC rules and regulations before offering or charging for this service.

Why Bother Modifying A Loan?

If you or a struggling borrower is unable to make their loan payments, the lender has a few options. They can:

1. Invoke foreclosure
2. Garnish wages and attempt collection
3. Wait to collect during bankruptcy
4. Work with the borrower to modify loan terms

In many situations, it is in the best interest of both the lender and the borrower to modify the loan rather than accept a more costly option.

What’s Next for Commercial Loan Modifications?

Recent trends show that mortgage loan modifications are decreasing. According to Hope Now, a loan modification consumer advocacy organization, “permanent loan modifications were down 40% in 2011 from the previous year.”

Why is this?

Many mortgage holders simply cannot afford to stay in their homes – even if loan modification occurs.

Property owners who bought during the real estate bubble likely owe a substantial amount more than what the property is currently worth. Because of this, even a generous loan modification may not be enough to avoid foreclosure.

Despite this recent downturn, commercial loan modification is still a viable option for many struggling borrowers. In the end, each situation is unique.

What may work for one person, may not work for another. If you are interested in commercial loan modification, either as a consultant or struggling borrower, be sure to weigh all your options carefully and educate yourself.

Yet, these stories do not always end well. In recent years, there have been a host of companies and individuals posing as loan modification specialists.

According to Patrick Dunlevy, a Los Angeles-based pro-bono attorney, “Foreclosure rescue scams are our number one complaint right now.”

Not only do unsuspecting homeowners lose money, they are left in the same position as they were before the scam: with an unmodified mortgage they can’t afford.

Common Scams

There are many different types of reported scams, but here are the three most common:

1. Processing fees & disappearing act – The scammers will offer their modification services, often charging an “administrative” or “processing” fee of up to $7,000. After the fee is collected, they will disappear with the money.
2. Modified payments – The scammers trick homeowners into paying the “modified” monthly mortgage payments directly to the scam artist rather than the Lender.
3. Fake government affiliations – The scammers will fake an affiliation with the government and charge an up-front “qualification” fee and disappear.

Remember, the above list is by no means exhaustive. Scammers come up with new ways to trick homeowners every day.

How to Not Come Across as a Scammer

Helping homeowners and commercial property owners modify their loans for a consultant fee is a legitimate investment strategy – as long as you follow the rules.

The Federal Trade Commission recently passed rules regarding loan modification services. Any and all companies or individuals offering this service:

1. Cannot charge an advance fee – The fee for negotiating modification is not to be collected until after the loan has been modified and approved by both the Lender and the Borrower.
2. Must provide full disclosure – The company or individual must provide full disclosure, including non-affiliation with the government.

As an investor, you may get this objection. The best way to deal with it is to be upfront and honest and show testimonials and references to potential clients.

Here are a few past articles on this topic that can help you present your business to cautious prospects:

• Dos and Don’ts of Working Short Sales and Loan Modifications
• Five Fails Newbies Make That Can Cost You
• Who Are Your Prospects?

In order to understand what Commercial Loan Modification means, let’s break down each word and define it:

• Commercial: Related to business. We are only concerned with loans taken out for business purposes. This does not include an individual loan for something like your car, home mortgage or an educational loan.

• Loan: A sum of money lent for interest.  A lender will loan an amount of money to be repaid with interest by the borrower.

• Modification: Allowing modification of a loan without requiring refinancing. If a business suffering financial hardship cannot meet its loan payments, modification of a loan may occur in order to avoid default.

From the definitions above, we can see that a commercial loan modification is when you change a commercial or business loan, but you don’t refinance.

When Is Loan Modification Considered?

A lender, such as a bank or private investor, will prefer refinancing to loan modification. However, if a business is suffering financially and cannot meet its loan payments, modification may be allowed.

A Lender will consider the following when deciding whether or not to allow loan modification:

• The reason and circumstances surrounding financial hardship of the business.
• Whether or not foreclosure would prove more profitable for the Lender.
• The equity of the loan.
• The amount still owed on the loan.
• The borrower’s credit history.
• The consequences of loan default. For example, if the loan is a mortgage for a multifamily rental dwelling, displacement of residents on a foreclosed property should be avoided if possible.

How Can A Loan Be Modified?

There are several ways in which the loan can be modified. Here are just a few examples:

• The number of years to repay the loan may be extended.
• The interest rate may be lowered or changed to a fixed rate.
• Part of the loan may be forgiven.
• Missed payments may be forgiven or added to the loan balance.
• Monthly payments may be reduced or payment dates extended.

What Does All This Mean For The Investor?

Investors can benefit from commercial loan modification in two ways.

1. As a borrower, you may have invested in property but are having trouble repaying your loan. If refinancing is not an option, commercial loan modification is one possible solution. To make this happen, you may either approach the lender on your own or speak with a commercial loan modification specialist.

2. If you are already familiar and experienced with loan modification, put your knowledge to work for a fee. You can renegotiate a struggling borrower’s loan and make money as a consultant. Just be sure to follow all of the FTC rules before attempting to charge a fee for your services.

Have you ever worked with a commercial loan modification? Is this something you’re interested in looking at as an investment stream of income? Tell me about it in the comments below.

Often, in bad economic times (like the past few years), companies need to reduce their asset load due to decreases in property values. In essence, the properties that were once assets are now burdens and foreclosure is a very real possibility.

However, for an investor with a focus on what will happen down the road – not how the next mortgage payment will be made – this can be an opportunity. And a commercial short sale may be the best avenue for an investor to help a company or individual facing commercial foreclosure.

In today’s tough credit market, it’s not easy to get credit and often commercial loans require a personal guarantee, so Mr. Business Owner may be in more than a tough spot company-wise; he may be looking at taking a personal hit if the bank forecloses.

When the bank allows a short sale, the bank may come out better than if it did foreclose. According to an article from Forbes, the trend of foreclosures on commercial properties has increased exponentially since 2006.

Additionally, a 2010 report from the Congressional Oversight Panel called Commercial Real Estate Losses and the Risk of Financial Stability estimates that commercial loans made over the past 10 years total will require refinancing between now and 2014. The estimated $1.4 trillion in at-risk loans includes properties such as retail space, office buildings, industrial plants, hotels and apartment buildings.”

The Congressional report said, “A significant wave of commercial mortgage defaults would trigger economic damage that could touch the lives of nearly every American.” It points to the aftermath of a commercial property takeover – loss of jobs, loss of community value (abandoned store fronts, office buildings and apartments) and even the failure of banks in the community.

The Forbes article said that “a further spike in delinquencies would strain banks and then dry up funds for future commercial borrowers.”

So, are commercial short sales the answer to this dilemma? Maybe, maybe not. However, these sales could ease the burden on banks and struggling companies.

As we’ve seen from the two previous sources, banks are already struggling with too many foreclosures. The market is flooded with properties that were sold at the top of the real estate bubble Mark Bergen makes a very good point in the Forbes article, “Loan restructuring and credit easing and interest rate guarantees won’t go all that far if people just aren’t buying your stuff.”

Investors have an opportunity to help the commercial market through short sales but it’s important to follow the rules, to ensure it’s a good investment and to have an attitude of helping the situation.

Short Sale Defined

A short sale is basically selling a property at the current market rate without adding in the debt owed to the owner or lender. This sale has to be approved by the mortgage holder in order to make the transaction happen, so that’s where the work starts.

The Process

The first step to beginning a short sale is to get a market price for the property. A real estate agent or appraiser can help determine the property’s current value. If there’s a big difference in the current value and the amount owed on the property, it may be a good idea to involve a loss mitigation specialist. This person can also help in complicated situations or in the event the seller is in unfamiliar territory. Short sales have a lot of steps and regulations, and a specialist can help the process along.

After determining the property value and deciding whether to involve a loss mitigation expert, the seller (or loss specialist) will develop a proposal for the lender. The proposal will break out the financial risk a lender will take in the event of a foreclosure and compare it to how the lender comes out in the event of a short sale.

The property you’re looking at or trying to short sell probably needs improvements and that needs to be factored into the proposal for the short sale. Don’t just give a lump sum on the amount of repairs needed. Get contractors to give estimates and include those with the proposal.

Finally, you’ll need to craft a letter of hardship. This letter should explain the current financial situation and the projected situation for the underwater mortgage payer.

The idea is that you’ll have to do all of the legwork (told you this was boot camp) to create a solid proposal.

The lender will work through the proposal and give an approval or denial of the short sale.

What’s In It for Investors?

You can specialize in short sales and build a network of rentals or flip short sale properties. In order to specialize in this area, you need to understand how to structure the proposal or have a loss mitigation specialist on your team. You’ll also need to do thorough market research to ensure the deal is a good one.

Stay tuned for more lessons this month on commercial loan modifications and workouts.