At this point, we all know too well that Covid-19 has dealt a strong blow to the economy. For commercial real estate owners, this means many are faced with the prospect of default on mortgages secured by their properties. This article will explore two programs that could help real estate owners and borrowers as they grapple with the financial effects of Covid-19.
Many are aware that, in response to the ongoing economic fall-out from the Covid-19 pandemic, Congress enacted the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). The CARES Act authorized more than $2 trillion to create numerous programs, ranging from immediate cash relief for individual citizens to loan programs for small business to various types of economic relief for impacted businesses and industries.
The most familiar program created under the CARES Act is the Payroll Protection Program (PPP). The PPP provides loans to small businesses so they can keep their workforces employed despite any financial hardship resulting from the Covid-19 pandemic. A key feature of the PPP loans is that they may be forgiven under certain circumstances. While this is an extremely important program for the well-being of our economy, the PPP does not squarely address the specific needs of the commercial real estate sector.
Main Street Lending Program
Of interest to commercial real estate borrowers is another program created under the CARES Act, the Main Street Lending Program (MSLP). The MSLP is available to small and medium-sized businesses that were financially sound before the COVID-19 pandemic and were either not eligible for a PPP loan or that continue to need financial support after receiving a PPP loan. A key distinction between the PPP and MSLP is that the MSLP loans cannot be forgiven.
The MSLP is administered by the Federal Reserve. Using a “special purpose vehicle,” the Federal Reserve will purchase a 95 percent participation in each loan made by an eligible lender to an eligible borrower, with the remainder of the loan retained by the eligible lender. There are three loan facilities available under the MSLP that include secured or unsecured (subject to certain lien priority requirements) term loans and revolving lines of credits. However, not all commercial real estate borrowers are eligible for MSLP loans.
“Eligible Lenders” include any U.S. federally-insured depository institution (including a bank, savings association, or credit union), a U.S. branch or agency of a foreign bank, a U.S. bank holding company, a U.S. savings and loan holding company, a U.S. intermediate holding company of a foreign banking organization, or a U.S. subsidiary of any of the foregoing.
“Eligible Borrowers,” among other things, must (i) be based and incorporated in the United States, (ii) have been established before March 13, 2020, (iii) have either fewer than 15,000 employees or annual revenues of $5 billion or less, and (iv) not be an ineligible business as that term is defined in the Small Business Association regulations. This final requirement means that passive real estate companies, such as special purpose entities that own a single asset but do not “actively use or occupy” that asset, are not eligible for loans under the MSLP.
Another impediment keeping commercial real estate borrowers from taking advantage of the MSLP is that often these owners are the same borrowers that underpin the commercial mortgage-backed securities (CMBS) market. CMBS loans typically restrict a property owner’s ability to take on additional debt, which means a loan under the MSLP likely is not an option. In short, the MSLP may not be available to many commercial real estate borrowers.
HOPE Act
For these reasons, the recently introduced “Helping Open Properties Endeavor Act of 2020,” or the “HOPE Act,” seeks to address this gap in assistance for commercial real estate borrowers. Originally proposed by U.S. Rep. Van Taylor (R-TX) in early summer, a revised bipartisan bill was introduced in late summer by U.S. Representatives Van Taylor (R-TX) and Al Lawson (D-FL). In a nutshell, the HOPE Act proposes that the Federal government take a preferred equity stake in struggling commercial real estate properties. Preferred equity is similar to a fixed-rate loan, but takes a subordinate position to any existing mortgage, which means, if drafted correctly, it could be available to CMBS borrowers.
Specifically, the HOPE Act would allow eligible financial institutions to purchase preferred equity in eligible borrowers and the federal Department of the Treasury would guarantee 100 percent of each purchase. Funding for this program is available under Section 4003(b)(4) of the CARES Act, which appropriated money for providing liquidity to eligible businesses.
Of note, the amount that may be paid by eligible institutions for these instruments is capped at 10 percent of the outstanding debt owed on the mortgage secured by the same commercial property.
Also of note, the HOPE Act targets commercial properties that are not otherwise eligible under the MSLP – meaning, passive real estate owners are eligible whereas owner-occupied property owners are not eligible. Properties acquired through foreclosure after March 1, 2020 also are ineligible.
To be eligible, the property owner must also have experienced at least a 25 percent decline in revenue during any three-month period after March 1, 2020, as compared with the same three-month period during the previous year. There are two additional eligibility requirements relating to the soundness of the property owner’s financial condition prior to the Covid-19 pandemic. First, as of March 1, 2020, the property owner must not have received within the previous year notice of a monetary default that remains uncured. Second, the property owner must have had a debt service coverage ratio of at least 1.3 times on an annual basis either (i) during 2019, or (ii) during both 2017 and 2018. These pre-pandemic financials could limit the pool of eligible borrowers.
Though the recent bipartisan sponsorship of the HOPE Act is a positive step toward providing relief, albeit limited, to commercial real estate borrowers, it remains to be seen if the Act will be adopted. As of the writing of this article, the bill remains in committee awaiting further action.