July 2, 2020
By Tom Hershey and Dan Spiegel
The struggle to keep occupants and landlords solvent is a reality, as both seek near-term relief from their obligations. The current environment has left many tenants and their landlords wondering what mutually beneficial actions can be taken to avoid worst-case scenarios at commercial properties across the country.
Landlords who must maintain specific occupancy rates under the terms of their loan or are tight on cash flow due to delayed move-ins and slowdowns in tenant improvement construction may feel increased pressure to renegotiate lease terms. Commercial property owners, however, will likely refrain from making decisions on their own, without consideration for an asset’s debt structure. The decision to offer incentives or concessions may address the tenant’s needs but it is a lender’s willingness, or ability, to work with the owner which may determine how much flexibility an owner has to offer modified lease terms.
States and Municipalities Chime In
Compounding the rent collection struggles faced by commercial property owners, several states are now recommending that landlords halt rent increases and end evictions, while some municipalities have gone so far as to give formal orders for moratoriums on evictions. Owners are also increasingly aware that some financially strong tenants are seeking relief simply because of the current environment, a scenario that benefits the occupant at the expense of the owner. Other factors such as co-tenancy clauses and minimum occupancy terms are exacerbating problems for many retail landlords. This has property owners seeking relief as well. The situation is akin to pushing the first domino down in a chain of interdependent parties in the real estate food chain.
As the Rent Stops, Will the Mortgage?
Without a steady stream of rental income, making debt service payments has become a struggle for many landlords. As such, mortgage delinquencies are beginning to inch up. CMBS rates bumped up to nearly 2.3% in April with further increases likely in May. This is still well below the peak of the Great Recession, and lower than April 2019, but most economists believe that this could be only the beginning. While most of the delinquencies are expected in the retail and hospitality sectors, initial delinquencies have been broad-based.
As an increasing portion of property owners struggle to meet their debt service, most are more than willing to work with their occupants as they strive to maintain occupancy rates and retain as much income as possible. There are several scenarios that come into play when considering rental modifications for delinquent tenants, all of which require careful deliberation and open dialogue with the owner’s lender. Loan terms vary greatly, especially between traditional loans and CMBS loans.
Lenders May Be Your Partner
Outside of the CARES act and the PPP, which did not provide direct relief for many property owners, there are limited avenues for landlord assistance. Approaching the lender for loan modifications, or temporary forbearance, is thus a logical step for many. As some leases require lender consent for any lease modifications, and others require specific debt-to-income ratios, a vital first step is that property owners understand the covenants in their loan documents prior to opening communications channels with their bank. Grasping how the loan is structured beforehand can give the debtor an idea of which pathways to take when negotiating.
The question then becomes, “Will the lender negotiate?” The answer? It depends. For the most part, banks are expected to be flexible, but it is unlikely that we will relive the “blend-and-extend” perpetuality of the Great Recession. While lenders typically do not want to foreclose, landlords would be wise to begin negotiations fully prepared. Property owners should compile as much information about their past, current and future financial situation and should be equipped to demonstrate the reasons for the debt relief request. Moreover, borrowers should have well-thought-out suggested loan modification ideas in advance. Having documentation from tenant requests will also be key. For example, some owners are employing signed documents with their tenants that state any renegotiations are subject to lender approval. This not only protects the landlord against unforeseen ramifications of loan constraints, it provides the lender with a clear request from a tenant.
Just as landlords may make stipulations with tenants when relief is granted, so too may lenders of borrowers. Owners should consider approaching their bank before they become delinquent or enter a default situation, as doing so after could weigh in the lender’s favor. Lenders will likely have modification ideas of their own and may look to better protect their position with more constrictive loan terms as well. Borrowers could face changes to guarantees, future interest rate adjustments or increased cash reserves.
Complication: Securitized Debt
Borrowers who utilized conduit lenders for property acquisition may have a more difficult time with getting relief. CMBS loans provide a significant challenge when it comes to requesting loan modifications, as master and special servicers have limited flexibility in what they can do. While securitized debt owned by GSEs were provided with 90 days of relief in March, private CMBS deals were not in the mix. Through April, approximately 30% of borrowers with CMBS debt had approached their servicing agents for relief. Unsurprisingly, most requests came from owners of hotels, retail and multi-family assets. Despite the difficulties in working with the CMBS servicers, and their limitations in accepting loan modifications, owners should still approach their servicing agent with the same preparation as they would with a traditional lender.
A consensus has yet to be formed on the lending front on the relaxing of loan terms to accommodate landlords faced with tenant closures, but owners might consider opening the lines of communication with their lenders early on, rather than waiting until there is a dire situation. As always, landlords would be wise to seek market knowledge through brokerage representation and legal advice through counsel when considering lease modifications.
Tom Hershey is the national director of Servicing & Growth at Coldwell Banker Commercial. Dan Spiegel is managing director at Coldwell Banker Commercial.
Pictured, upper left: Tom Hershey. Below right: Dan Spiegel.
For comments, questions or concerns, please contact Paul Bubny