CLIENT ALERT
By: Bruce Bagdasarian
April 10, 2020
The Coronavirus pandemic has caused widespread hemorrhaging in the real estate industry. While the retail and hospitality sectors have taken the brunt of the crisis, all property types are being affected. And as tenants begin to suffer, so too will their landlords and their lenders. Tenants are looking for relief, and in turn, landlords and lenders are bracing themselves for requests for deferrals and perhaps reductions of rent or debt service, as the case may be. Each affected party will be well served by being proactive, not waiting for problems to arise, and being transparent about liquidity and other business and financial issues.
Tenant Considerations
Tenants that anticipate material reductions in revenue, and which need a rent deferral or reduction, should contact their landlords immediately to work through a resolution. In general, landlords will be more receptive to a deferral request, whereby the amount deferred can be paid over time. A rent reduction proposal may be a non-starter in most scenarios. However, some tenants, especially certain retail tenants, may take aggressive positions, suggesting that landlords be willing to forgive some rent rather than pursue eviction or causing the tenant to file for bankruptcy. Tenants may also seek to tap security deposits, with the agreement that the deposit will be replenished over time. Before approaching landlords, tenants should be intimately familiar with the current government relief programs and how they can be used as part of their strategy. Landlords will expect tenants to aggressively seek relief where it is available. To date, the two main available resources are (i) the Payroll Protection Program (PPP), where 75% of the funds borrowed from the federal government must be used for payroll and 25% can be used for rent, utilities or debt service in limited circumstances; 100% of the loan can be forgiven if the loan proceeds are used in the manner prescribed by the CARES Act, and (ii) Economic Injury Disaster Loans (EIDL), where low interest loans up to $2,000,000 are available. Prior to any discussion with the landlord, the tenant should review their lease agreement and be prepared to make a substantive proposal, including demonstrating what actions, if applicable, have or will be taken to seek appropriate state or federal government relief.
Landlord Considerations
Landlords should be assessing risks for each of their properties, identifying tenants which may likely be needing rent deferrals, and contacting tenants to see how they are faring. While it may seem like a bad idea to contact the tenant and open the door to requests for relief, it is arguably better to facilitate communication early and to get a sense sooner rather than later for which tenants are at risk. The sooner a landlord can assess the likely drop in revenue, the sooner it can project future revenue shortfalls and create a strategy for dealing with its lenders, which is a necessary part of the strategy when dealing with tenants. If a landlord is willing to work with tenants and defer or, in limited cases, forgive rents, it will need to know if its lender will be cooperative in deferring or reducing debt service payments. Otherwise, the landlord’s cooperation with tenants may result in the landlord struggling to pay debt service. In dealing with tenants, landlords should demand transparency and expect current financials from the tenants and the leases guarantors, if any, to better assess the tenant’s need for relief. In the case of multi-family lenders, some relief was recently provided by the federal government. For example, the FHFA recently announced that owners of multi-family properties subject to Fannie Mae and Freddie Mac-backed mortgages (which are regulated by the FHFA) will be permitted to defer their mortgage payments up to 12 months as long as they do not evict renters who are unable to pay their rent due to the COVID-19 outbreak. The CARES Act also provided for forbearance on debt service payments for certain government backed loans for multi-family and single family properties It is also worth noting that the banks have been encouraged by federal and state regulators to work with borrowers who are or may be unable to meet their contractual payment obligations on a temporary basis as a result of the COVID-19 pandemic, and the regulators have agreed that the forbearance of debt service payments will not be deemed a troubled debt restructuring, meaning the banks will not be penalized for restructuring loans with respect to when debt service will be repaid, which was not the case prior to the current crisis. The bottom line is that some relief is available to many landlords. So, just as landlords should be proactive with tenants, they should also be proactive in obtaining forbearance arrangements from their lenders, where needed.
Lender Considerations
Lenders should be identifying weaker credits where defaults are expected due to the tenant mix and where the borrowers are not well capitalized. Lenders should be contacting borrowers to get a real time sense of property performance and to identify loans that will need debt service deferrals. Banks should be working with borrowers to make sure the borrowers are taking prudent approaches with their tenants. To facilitate the loan restructuring process, borrowers and guarantors should be prepared to deliver current financials and to be fully transparent. Lenders should be willing to work with borrowers, in part because it is necessary and not the fault of the borrowers, and in part because of the regulators have encouraged the banks, as mentioned above. The challenge will be to determine the right amount of relief for each situation and to manage its own operations, given the shortfall in revenue. Lenders may have to temporarily suffer a hit to revenues, although the PPP and EIDL programs will soften the blow to lenders by providing commercial tenants with immediate funds to pay towards rent, and thereby reducing the revenue shortfall that landlords/borrowers will suffer. However, these programs will not cure all of the financial problems faced by tenants and landlords.
While the tenants may feel the greatest urgency in starting negotiation with landlords, landlords and lenders should also move quickly to identify problems and to confront them sooner rather than later. Given how tenants, owners and lenders are interrelated, they should each be fully aware of the government relief programs that affect them all. Without seeing the full picture, it is difficult to have an effective strategy for dealing with the current challenges.