Coauthored by Derek Uldricks
If you own commercial real estate as a partner, limited partner, member, or tenant-in-common, the odds are that neither your lender nor your servicer is the firm that lent you the money for your property. Many of the outstanding commercial real estate loans in the United States were pooled and then sold to investors as Commercial Mortgage Backed Securities (CMBS). Commercial real estate borrowers are sometimes surprised to discover that their loan is being serviced by a firm with which they have no relationship. These servicers, who oversee massive amounts of debt, are highly sophisticated firms that participate in a universe specifically known as CMBS and generally known as real estate capital markets, securitizations, or structured finance.
In the CMBS universe, mortgages are originated then pooled into Real Estate Mortgage Investment Conduits or REMIC Trusts. The basic idea is that the monthly loan payments, including the principal and interest, from many commercial real estate loans are combined and funneled through the trust. The periodic cash flows and the full principal repayment at loan maturity are similar to a bond and CMBS arrangers utilize this bond-like feature of mortgages to sell the bonds and the loan cash flows, as securities.
These complex REMIC Trusts help to provide the crucial liquidity lenders need to refinance existing debt and originate new loans. Most borrowers do not know who oversees their loan until their property becomes distressed and the loan is transferred to "Special Servicing." The REMIC Trust structure, while extremely complicated, can be simplified by highlighting the roles and responsibilities of two key players: the Master Servicer and the Special Servicer.
The Master Servicer is the entity that services the loan while it is performing and is meeting all of its debt service obligations. Amongst other duties, the Master Servicer collects payments from the loans and receives a small percentage of the aggregate loan balance (typically 2 to 9 basis points or 0.02 percent to 0.09 percent per annum). The Master Servicer then passes on the remaining balance to the investors that own the securities. Most commercial real estate borrowers have little to no interaction with the Master Servicer and only deal with the Special Servicer when their loan gets into trouble.
The Special Servicer gets involved when a loan defaults and is transferred from the Master Servicer to the Special Servicer. The Master Servicer has the power to transfer loans into Special Servicing when a loan or borrower becomes distressed. For example, if a loan reaches maturity and does not qualify for new financing, the Special Servicer has the authority to pursue remedies to resolve the default. Remedies can include workout options like a discounted pay-off, loan extension, or interest rate adjustment. Likewise, the Special Servicer can pursue more aggressive workout options, like foreclosure, unless they are challenged. The Special Servicer is an active debt collection organization and is obligated to maximize recovery for the REMIC Trust.
Many Special Servicers are owned by private equity/venture capital firms or Real Estate Investment Trusts (REITs) and employ savvy real estate professionals that deeply understand commercial real estate and securitizations. In many cases, special servicers are incentivized to foreclose on defaulted assets so that one of their affiliate companies can purchase the property or loan at a discount.
"Special Servicers can be in direct competition with borrowers to reach a suitable resolution," states Jack Rose, Chief Strategist at Breakwater Equity Partners. "Borrowers want to secure a deal that makes long-term economic sense. But if the special servicer is jockeying for ownership of the distressed asset, they have a clear conflict of interest with the borrower and maybe also the bondholders."
When the Special Servicer's ulterior motive to foreclose and subsequently purchase the asset, collides with the borrower's goals, the result can be disastrous for the borrower. Every borrower should employ experts who can utilize the right tools to secure the best refinance or restructuring possible.
Many borrowers don't have the specific knowledge to implement a refinance or restructuring plan on their own, and most borrowers will need to hire a team of savvy real estate and CMBS professionals. Servicers play an important part in the securitization process, but borrowers need to fully understand all of the major players, their roles, and their motives. The best way to start planning for your refinance or restructure is to learn more about Special Servicer's functions and roles and then secure your team of experts to negotiate on your behalf.