Most hotel owners received some type of forbearance on their loan payments due to the COVID-19 virus. Along with government assistance, this allowed the hospitality industry to survive through the worst of the pandemic. That’s the good news.
Now, here’s the bad news. On traditional loans, the structure of forbearance included deferring a certain number of payments and placing the missed payments on the back end of the loan, so it would be paid back at refinance or sale when the loan matures. CMBS forbearances included the same deferral structure with one significant difference. The deferred payments must be paid back within approximately one year of receipt of the forbearance, not at the maturity of the loan. The most common number of payments deferred in CMBS was 12, which equates to a deferral of the April 2020 through March 2021 payments.
Beginning in April 2021, hotel owners had to resume making full debt service payment, and shortly thereafter, had to start paying back the 12 months that were deferred. This means that a lot of owners are required to make two full payments beginning this summer—even though many of these hotels could not support two full debt service payments before the COVID-19 outbreak.
While some owners may opt to self-fund the revenue gap created by the pandemic, there are other options available to hotel owners faced with filling the gap where the property performance doesn’t support it.
Seek outside capital.
The most viable way to bring in outside capital to fund the shortfalls created by the pandemic is via preferred equity. CMBS loans do not allow for the addition of debt to the structure, so mezzanine loans are typically not allowed. There are many preferred equity providers in the market today and many that understand the nuances of preferred equity in a CMBS structure. It will make the process much smoother to choose an equity source that has knowledge of CMBS.
Although each loan document can vary, generally, CMBS loans require servicer approval for the addition of preferred equity if the preferred equity provider will have any control or decision rights in the borrower, or the equity provider has cure rights upon the owner’s default. Almost all preferred equity structures contain these provisions, so expect that the servicer will have to approve the addition of the equity. This approval typically takes 60 days and often requires the payment of a significant fee to the servicer (typically one percent).
2. Sell the property.
If an owner chooses to sell, the buyer may opt to assume the existing loan—or in some cases, the existing loan can be paid off through the sale. The looming potential change in the 1031 exchange laws, plus the revenue uncertainty created by COVID-19, is causing many hotel owners to pursue the sale of their hotel. Keep in mind that CMBS loans are locked out from prepayment, so the sale would require the buyer to either assume the existing loan or defease the loan. Defeasance is a costly proposition, so an assumption is highly likely.
Assuming a CMBS loan is also tricky when there is an existing forbearance in place. The servicers will typically require that all past due amounts be brought current at the time of the assumption. The buyer will also need to pre-fund reserves to decrease the odds of the property defaulting in the future. Loan to purchase price also matters at the time of the assumption. Obviously, all these factors could create a scenario where it isn’t worth it for the buyer to buy the property. A CMBS advocate who has handled many COVID-19 forbearances and assumptions is truly needed during this process.
Assumptions will typically take 60 to 90 days to close and will be subject to the assumption fee in the loan agreement, which is typically one percent.
3. Permanently modify the loan.
This option essentially eliminates the repayment of the deferred amounts; however, only certain properties would qualify for this option. While forbearance was essentially “kicking the can down the road,” a modification would entail a permanent change to the terms of the loan. So, instead of deferring 12 months of payments and having to pay it all back later, the loan might be modified such that the payments are two percent interest for a few years, with nothing being deferred.
To determine whether a property qualifies for a permanent modification of a loan, a hotelier must ask several questions. Is the value of the property currently less than the loan? If the answer to this question is “no,” the loan will not likely qualify for a permanent modification. Secondly, is the value of the property likely to recover to the loan amount by the maturity of the loan? If the answer to this question is “no,” a permanent loan modification is likely.
There are various forms of modifications and ultimately the outcome is dependent on the property, the CMBS pool, the capital required to stabilize the property, as well as other factors. Some of the common types of modifications include discounted payoff, interest rate reduction, or maturity extension. A CMBS advocate who has handled many COVID-19 forbearances and modifications is needed during this process.
4. Hand the property back to the lender via a deed in lieu of foreclosure.
CMBS loans are non-recourse, so another option is to hand the property back to the “lender.” This is obviously a last resort. There are many factors to consider when choosing this option, including tax consequences, any partial guarantees that exist, and most importantly, the specifics of the carve-out guarantees. This may sound like an easy, clean option, but there are many pitfalls associated with handing a loan back to the lender without triggering any of the carve-out guarantees. Always, always, seek professional help when pursuing this option.