By Hugo Dorta, Founder + Principal of Brickell Capital
Covid-19 has interrupted most day-to-day consumer activities as well as regular business operations. Hotel and retail sales have decreased as consumers reduce spending, and tenant businesses have suffered as they operate at low capacities. Moreover, local governments are limiting and shutting down construction, preventing future development, and no one is sure how long these circumstances will last.
These conditions and the onset of a COVID-19 induced recession will affect real estate borrowers and, possibly, their ability to fulfill monetary obligations. Therefore, there are certain things that Borrowers should be doing to mitigate the financial risks caused by a recession. In order to reduce the economic impacts of COVID-19 and the uncertainty of the crisis’ duration,real estate borrowers should speak with their lenders and creditors to minimize the impact of the pandemic on their businesses and debt obligations.
1-Main Open Commutation with Your Lender. Borrowers must understand that in times of crisis, it is in their best interest to maintain open communication with their lenders and loan servicers. They should contact their lenders at all times even if they are not facing difficulties because their situations could change as the recession drags on or if the economy continues to be stagnant for a prolonged period. Open communication ensures that borrowers are transparent about their circumstances, which makes them more likely to obtain relief. Lenders are more prone to offering assistance if their borrowers are transparent about their situation, not only because it may garner sympathy but because it increases reliability
Borrowers must also review their loan documents to make sure they are in compliance with the loan requirements (i.e. minimum debt service coverage ratios). Moreover, borrowers should establish easier and faster methods of communication with their lenders. For example, they should tell lenders to communicate notices through email to implement more recurrent contact between the two parties.
With regards to construction loans, many borrowers are attempting to assert their inability to comply with negotiated performance milestones by using force majeure notices. The term "force majeure"means unforeseeable circumstances that prevent a borrower from fulfilling a contract, and thus allowing a borrower to cancel or postpone payment and performance due to impossibility of performance. Due to dire circumstances,Borrowers are attempting to use this affirmative defense in order to walk away from their legal obligations. In this regard, borrowers that invoke force majeure must show a causal link between the force majeure event and how it has caused them the failure to perform. Moreover, some loan documents require that borrowers describe their mitigation efforts in detail if invoking force majeure, so borrowers need to be as specific as possible.
In the event that borrowers are requesting a meeting with your lenders to discuss loan terms or the borrower's inability to repay a loan, you shall be expected to sign a pre-negotiation agreement, or PNA. Borrowers should know that this is standard procedure before discussing loan terms and potential loan modifications.
PNAs merely maintain the status quo and allow borrowers and lenders to undertake non-binding discussions without waving any rights. For example, if a borrower is in default and they meet with their lender, a PNA will allow both parties to talk freely since the discussion will be non-binding. Nevertheless, in these discussions, borrowers should avoid admitting defaults,waving defenses, and granting concessions to the lenders in PNA agreements.
2-Understanding COVID-19’s Impact on Monetary Obligations. It should be noted that while many borrowers may want to invoke force majeure, it almost never excuses borrowers’ debt obligations. Instead,what borrowers could do is talk to their lenders about temporarily restructuring loan agreements, more specifically, loan repayments, in order to get some assistance in times of crisis. Although there is no guarantee that lenders will agree to loan modifications, given the circumstances, some may be more be flexible with their borrowers. This is because it is sometimes in the lender’s best interest to cut out an agreement that will ensure repayment even if that means implementing more lenient temporary loan terms. Another option isasking lenders to allocate cash flows to property operations until borrowers are financially stable. Depending on the circumstances, this request may be more likely to get lender approval.
In other words, if a borrower anticipates temporary shortfalls, they should talk to their lender about using cash flow or cash reserves to pay electrical bills, insurance, taxes, etc. and avoid liens. Lenders may also agree to such requests since this will ensure that the property still brings in some revenue, which allow the borrower to meet future obligations.
If necessary, for loans with hard cash flow management issues, borrowers should request that lenders allow them to fund operating costs first. Like previously mentioned, lenders may be more likely to approve such requests since it is in their best interest that borrowers operate the property, generate a positive cash flow and fulfill their debt obligations.
Lenders could ask that borrowers invest more equity into a project to pay debts or operating costs. In situations like these, borrowers need to assess whether they have enough equity, whether they are committed to a project, and whether the recourse exposure, if they do not fund additional equity, is greater than the risks of continuing with the project.
There are other issues that borrowers must take into consideration and for which it is highly recommended that they seek legal counsel. They must ask themselves questions such as the following: is there a payment guaranty that assures additional costs are being paid through collateral ? .... or Is there a carry guarantee that covers operating costs of the property after completion of construction ? These examples take into consideration payment or carry guaranties, but there are many other matters that should be inquired and consulted.
Moreover, it is important that borrowers keep in mind their tenants’ situations and take measures accordingly. Some borrowers may be under alot of pressure from tenants, especially if they own retail like stores or restaurants. If tenants have asked for rent relief, borrowers should check their loan documents before approving such requests. Some loan agreements require the lender’s consent before giving rent relief. Even if rent relief is denied, borrowers should be openly communicating with their lenders and speaking to them about their tenants’ situations.
3-Take Advantage of Financial Assistance Being Provided During COVID-19. Furthermore, it is crucial that borrowers are aware of newly implemented financial assistance methods meant to alleviate the economic toll of the crisis. For example, Congress has assisted those having economic difficulties and has tried to alleviate the effects of the crisis by passing new comprehensive legislation.
Lenders have been instructed to provide 90-day forbearance of remedies for borrowers affected by the pandemic. For example, New York requires that financial institutions provide a 90-day forbearance of payment due on a residential mortgage property in New York to individuals who can demonstrate that COVID-19 has caused them financial hardship.
Although all circumstances differ, new regulations such as this one can serve as a guiding example when discussing forbearance options with lenders. Borrowers should take these regulations into consideration when requesting some sort of relief. Taking time to research COVID-19 regulations may be beneficial because it can help borrowers request similar assistance if necessary. Moreover, new regulations set a precedent that may make lenders more prone to agree to forbearance of collection, if appropriate.
It should also be noted that impaired borrowers who were not impaired prior to COVID-19 may be more likely to receive lender approval.
Government agencies such as, Fannie Mae and Freddie Mac are providing forbearance remedies to affected borrower. Fannie Mae and Freddie Mac are home mortgage companies created by the U.S. Congress that operate through banks. They do not originate or service mortgages, but they purchase mortgages from banks. Because of COVID, both Fannie Mae and Freddie Mac have implemented multiple relief options. For example, they are using their services to provide relief by reducing or suspending mortgage payments while borrowers regain their financial footing.They may do this for up to three consecutive monthly payment dates to borrowers impacted by the pandemic and who satisfy certain conditions
Congress has also passed the CARES Act – Coronavirus Aid, Relief and Economic Security Act –, a government stimulus program that provides relief to businesses and individuals. It protects both employees and business owners and injects money into the economy. The program offers funding for and expands eligibility under certain loan programs by the U.S. Small Business Administration (SBA), a government agency that provides support to entrepreneurs and business owners. Due to the COVID-19 crisis, this agency has provided guidance,loan resources, and recovery information. If necessary, business owners can apply for an SBA loan through the CARES Act, which can cover two to four months of employee payroll and other operational expenses.
An important thing for borrowers to take into consideration is that loan documents may require the lenders to consent to SBA loans. Under this Act, borrowers are entitled to apply for three to six months forbearance from their lender. Therefore, borrowers need to review their loan covenants and talk to their lenders regarding the CARES Act.
Many government agencies like the Federal Reserve Board and the Office of the Comptroller of the Currency are offering assistance in interpreting certain CARES Act provisions, such as forbearance programs for federally backed mortgage loans and the suspension of GAAP (generally accepted accounting principles) requirements for debt restructurings. They are providing certain guidelines for financial institutions working with customers troubled by COVID-19. Borrowers can use the assistance issued by these government institutions to their advantage.
The guidelines encourage that financial institutions work sensibly with borrowers experiencing hardships due to COVID-19 and struggling to meet their obligations. For example, the Office of the Comptroller of the Currency announced that it will be modifying loans and implementing modifications such as payment deferrals, which is a drastic measure.
Another source of assistance for borrowers are insurance consultants. Although it is unlikely that insurance coverage applies in COVID-related conditions, insurers can examine whether the borrowers’ insurance policies can cover revenues lost due to government shutdowns.
Nevertheless, if borrowers can collect insurance due to a business interruption, they should review their loan documents’ insurance clauses in order to determine whether they are required to give these proceeds to their lenders or if the lenders have the right to distribute the proceeds.
Borrowers face many challenges during COVID 19, and to reduce and mitigate the risk, borrowers shall need to take certain cautionary steps.They should maintain open communications with their lenders, which will help alleviate the impacts of the pandemic on their properties, debt obligations and ultimately, the success of their businesses. They need to review that they are in compliance with the terms and conditions of their loan documents. Moreover,they must determine whether there will be operating shortfalls and if necessary, request that some of the property cash flow be allocated to operating costs. They need to consider whether they can or would like to further invest more equity into a project. Finally, they must also take advantage of other forms assistance that are being made available such as government stimulus programs and insurance coverage. Borrowers that communicate with their lenders are protecting their assets and relationship with their lender, which will help them brace the impacts of the pandemic and facilitate recovery.
How Covid-19 Recession Will Impact Commercial Real Estate Values
Hugo Dorta, the author of this article, is the Founder and Principal of Brickell Capital.
Brickell Capital is a Florida “private bridge” mortgage lender. We specialize in residential and commercial loans for Self-Employed Borrowers and Foreign Nationals, New Construction Loans for Builders/Developers + Loan Servicing. Brickell Capital also purchases and services distressed mortgage loans. We purchase seasoned performing (and non-performing) first and second mortgage lien loans; sub-performing mortgage loans; mortgages in bankruptcy and foreclosure; investor fallout loans;scratch and dent loans, and aged mortgage loans on warehouse lines.
For the last 3 years, Brickell Capital was voted "Top 20" Commercial Lenders and Brokers by the South Florida Business Journal (South Florida's leading news outlet for residential and commercial real estate, banking, finance and business news).
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