by RUSHI SHAH
Every business in America has been impacted by the COVID-19 pandemic and we are facing an unprecedented crisis in world history. Today’s environment is unchartered territory for most business owners and especially jarring for hoteliers, who have enjoyed robust returns for a long time.
We are in the midst of the very definition of a black swan event. In other words, a high-standard deviation, low-probability event that usually occurs once in a lifetime for an average person. While investing in real estate or any other asset class, investors often look at these types of events as outliers or anomalies, subsequently discarding them from their investment thesis. Hence, they make a mistake of paying a higher price for an asset that merits a lower valuation. Hindsight is of course 20/20, and as they say, markets are efficient. So, most private and public assets should reflect these risks in their prices.
According to a recent Trepp report, which merges real data and educated assumptions to create predictive models, cumulative losses in the lodging sector may reach as high as 34.8 percent by the time this crisis subsides. This means that within the next 18 months, a staggering 34.8 percent of all hotels will likely face default. Retail is not far behind with predicted cumulative defaults of 16 percent. The federal government has stepped up to put money into citizen’s pockets and provide financial relief for businesses. But with every industry facing an immense magnitude of losses at the same time, it can only do so much. Not to mention it also must navigate the political obstacles (especially for our current administration) of appearing to favor hospitality over other industries.
Considering these significant challenges, it is imperative that hotel owners proactively address their current financial situation in a thoughtful, logical, and rational manner. Otherwise, they risk losing their hard-earned assets to creditors and bondholders. There are steps hotel owners can take, but available tactics will depend on the type of financing currently in place.
WHAT BANKS AND OTHER BALANCE SHEET LENDERS CAN OFFER
Conventional balance sheet lenders such as regional and local banks, and credit unions are more inclined to be flexible in deferring payments for a short period of time (typically three months with a possible three-month extension, if needed) because their loans are full recourse. These entities understand and can quantify their ability to recover these loans when the market improves. Additionally, these lenders are simply adding the interest to the back end of the loans, in most cases charging interest on interest. Similarly, SBA loans are backed by the full faith and guarantee of the federal government. Thanks to the extensive stimulus package signed by the federal government, SBA lenders are compelled to waive interest and principal payments for six months. The federal government announced that it will make debt service payments for six months for all current and new SBA loans, which, I believe, is an extremely accommodative stance on its part.
WHAT MOTIVATES COMMERCIAL MORTGAGE-BACKED SECURITIES (CMBS) INVESTORS
Unlike bank and SBA loans, CMBS loans are packaged into bonds and sold to private bond holders. This mechanism has increased the availability of non-recourse capital for hotels in secondary and tertiary markets, and enabled borrowers to secure attractive, long-term financing without personal guarantees while also monetizing the value they had built up as cash out. Those bonds are further bifurcated into controlling class and non-controlling class of bonds. The controlling class is typically owned by the b-piece buyers, who assume the lion’s share of risk. Some examples of b-piece buyers are Rialto, Ellington, Prime, KKR, Eightfold, Torchlight, C-III, and Argentic. This is important in today’s crisis, because if b-piece buyers fail to collect debt service on these loans, they could lose their principal balance. To protect their investment, b-piece buyers nominate special servicers (either owned/controlled by them or a third party) that the primary or master servicer (where payments normally are sent and who has no authority to make changes to the loan) can invoke to review and grant any changes to the loan. At the time of this writing, the special servicers have not come out with any wholesale guidance on how to handle the current COVID-19 triggered crisis. For CMBS borrowers who were in good standing on the loan prior to the crisis, however, the special services may grant a forbearance or deferment up to 120 days as a temporary reprieve. Consequently, it is likely in a CMBS borrower’s best interest to have their loan moved to special servicing. Another approach that has worked is to ask the CMBS servicers to apply any collected reserves toward the loan payments. This eliminates the need to move the loan to special servicing.
Despite the inflexibility of the servicers, as we enter into a prolonged slow period, hotel owners with non-recourse CMBS loans may actually be in a better position compared to assets with full recourse loans. CMBS borrowers benefited from the valuable tax-free cash outs that allowed them to grow their portfolios, longer-term savings from low interest rates and increased cash flow due to longer amortizations, all without the burden of personal guarantees. In addition, at the time of origination, the valuation for most assets that were administered for CMBS loans were likely higher than what they would typically get with a local appraisal. Furthermore, the borrower holds the negotiating leverage with a non-recourse loan. If the CMBS lender refuses to negotiate, the borrower can simply give back the asset and the lender cannot go after the borrower’s personal assets. This is starkly different from a guaranteed loan, where the borrower’s personal wealth is always on the hook to satisfy the loan. Looking back at the 2008 market crisis, the borrowers that avoided massive personal losses were those with non-recourse loans.
WHAT CMBS BORROWERS CAN DO TO SEEK RELIEF
If you have a CMBS loan and are in distress, it is critical that you communicate with your primary/master servicer as soon as possible to provide a compelling reason to transfer your loan to special servicing or request to apply reserves for payment. In addition, be sure to ask for temporary crisis-related payment relief. When requesting to defer payments or be granted forbearance, you must offer reasonable structure in exchange, so the lender knows you have no intention of defaulting in the long run.
In your communication, include your loan number, the name of the asset, and the location of your asset very clearly. Describe the situation succinctly, specifically, and quantitatively. Demonstrate how your asset performed pre-crisis, how your asset is doing now, and how you expect your asset to perform post-crisis. Include as much data as possible to back up your assertions. For example, compare current PACE reports with the same period in 2019. Include cancellation data and cash flow projections for the immediate future. Be sure to highlight your good history, guest satisfaction scores, and quality reports of the hotel. Include your RevPAR penetration per your pre-crisis STR report before crisis, and your current ranking compared to your peers. Also address any recent capital expenditures you’ve put into your asset. Finally, address what is happening locally and show that if it weren’t for the COVID-19 crisis, your hotel would otherwise be fine.
HOW NEW GOVERNMENT ASSISTANCE PROGRAMS CAN HELP
Prudent hotel owners who are committed to holding onto their properties should ensure they have enough cash to withstand the current business shutdown brought on by this crisis, as well as the likely ongoing economic slowdown. The federal government also is stepping in to help. Through its various SBA programs and authority, it has rolled out and expanded several programs to help all business owners to its maximum ability. Hotel owners can take advantage of three specific programs to help alleviate short-term cash flow needs.
ECONOMIC INJURY DISASTER LOAN
Hotel owners can apply for an Economic Injury Disaster Loan (EIDL) directly through the SBA. This program provides loans up to $2 million based on 50 percent of 2019 gross revenue.
PAYCHECK PROTECTION PROGRAM
The Paycheck Protection Program (PPP) within the CARES Act offers non-recourse, non-collateralized loans for 2.5 times the average monthly payroll up to a maximum of $10 million for companies with 500 employees or less. The loan is designed to retain workers and can be used to cover payroll, health care benefits, mortgage interest, rent, and utility payments. It is 100 percent non-recourse, unsecured, and fully forgivable.
SBA EXPRESS LOANS
The SBA Express Loans for Working Capital under the CARES Act provides loans up to $1 million (increased from $350,000) with 36-hour approvals. Hotel owners can apply for PPP and the SBA Express Loans through SBA-designated banks or intermediaries with pre-existing relationships with SBA lenders. All of these new programs, and any existing SBA programs, will waive six months of debt service. These loans can help cover most limited-service hotels for a short-term disruption in operations.
To further improve their chances of success, hotel owners can leverage expert resources, such as an experienced financing intermediary or a restructuring specialist. Resources are available and willing to help. Having an expert who understands CMBS, has relationships with SBA lenders and their programs, and can serve as an advocate can be a positive game-changer as owners navigate these challenging times.
RELIEF FOR CMBS BORROWERS
Communication is key. When requesting special servicing from your primary servicer, be sure to include the following information:
- State your loan number, asset name, and location clearly.
- Describe your situation in detail – succinctly and quantitatively.
- Compare and contrast your asset before the COVID-19 pandemic, how it is now, and your post-crisis expectations.
- Include data to back up your claims. Provide your good history, positive guest satisfaction score, quality reports on your property, pre-crisis STR, and compare your situation to your peers.