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No Way Out? Real Estate Lending Becomes Riskier

Real Estate

Every lender who provides funds for commercial real estate development expects to be repaid. That expectation, a fundamental part of our capitalist system, is the basis for a continuing willingness to advance capital to others. The lender looks first to the borrower, assessing competence, experience, and honesty, as well as the details of any particular development. Recognizing that matters do not always go as planned, lenders buttress their exposure to possible non-payment by “securing” the exposure by taking a mortgage or similar security device to give the lender a “second way out.” The lender can foreclose its security interest in the real estate and either develop the property or sell the real it to some new party.

What if the real estate is not particularly desirable, and cannot readily be resold? The disastrous collapse in the savings and loan crisis of the 1980’s taught many in finance that OREO is not necessarily a cookie; rather it is Other Real Estate Owned. Some institutions had property (sometimes with environmental issues requiring additional investment by the lender) for years. Something similar happened again in the Great Recession of 2007-2009, and this time almost all residential properties. Then came the e-commerce revolution and the bankruptcy of shopping malls. What to do with an empty mall? In some cases reported in the financial press, malls have been converted to community college campuses or healthcare centers.

Effects of the Covid Pandemic

Now we have seen two years of Covid pandemic. Many “downtown” office buildings are close to empty, and major employers continue to delay the reopening of in-person work. Perhaps, more significantly, in the long run, Covid and the growth of work from home using digital technology may result in a “Diaspora” of office workers, so that center city towers stand empty. What will that do to the lenders who financed the construction or acquisition of those properties?

In human history, to the extent it has been recorded and is accessible, advances in commerce, technology, and enterprise have occurred in cities. Since the days of Kush, Lagash, and Sumer, the gathering of men and women in a central location like the Agora in Greek City-States has led to both societal and scientific developments that have proven to be greater than the sum of their constituent parts.

One may read Plato, Aristotle, Machiavelli, Weber, Gordon Childe, and Edwin Banfield, perhaps, especially “The City in History” by Lewis Mumford, and find a continuing celebration of the role of the city and the consequences of an urban environment. What if the role of collective invention sponsored by city living has in fact been replaced in part or in whole by the “digital city” and the “internet community”? Clearly, the nature of personal interactions and the need for collective gatherings would be attenuated.

The Future of Real Estate

What about our poor friends (and clients), the lenders, who have financed structures no longer used or needed? On Monday, January 24, 2021, The Philadelphia Inquirer announced that it would move from its current quarters, the former Strawbridge & Clothier Department store, to one-third that space in the former headquarters of a chemical company, as it no longer needed the space with so many reporters working from home. Stories in the Wall Street Journal on Wednesday, January 26, 2021, reported that landlords of older New York City buildings (citing the Seagram Building as an example) are spending hundreds of millions of new dollars to upgrade the systems and amenities in those buildings. Other media report that office buildings in Virginia are being converted into residential apartments. The bricks and mortar of the past may not serve to house or not house the future. How does the lender cope?

H.L. Mencken is reputed to have said that ”to every complex problem there is a clear, simple answer – and it is wrong,” so I will not prescribe one. But it seems to me that a commercial real estate lender MUST ask itself at the outset, how can this structure be used, other than as it is currently being designed to be used? Again, there have been numerous articles in the financial press about the seemingly ever-expanding need for laboratory space for biotech start-ups and the like. What are the water and electric power needs for alternative uses? And what about waste and runoff disposal?

If the office building is converted into residential apartments, what plumbing, electrical, garbage, parking, and other needs must be considered? Perhaps a careful commercial real estate lender might have an alternative use assessment done at the outset, much as phase one environmental surveys are routinely done.


In any event, it does seem that the “second way out” is far less clear than it used to be, and that lenders need to address the increased risks in these changing economic and societal conditions. Consulting with an experienced business lawyer may also prove of assistance – especially before the funds are lent.

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