The next several months may be turbulent ones for landlords whose real estate financing hinges on commercial mortgage-backed securities (CMBS).
COVID-19’s economic impact is continuing to play out across real estate sectors. According to data from Trepp, which tracks the CMBS market, more than a quarter of hotels and 18 percent of retail properties with CMBS loans were in special servicing at the peak of default activity in 2020. Now, in the first weeks of 2021, Trepp reports that multifamily and office properties are “showing cracks, fueling concerns among investors, owners and lenders alike.”
As a result, more commercial landlords whose real estate financing includes CMBS loans may be seeking ways to avoid default. In doing so, they will need to work closely with their counsel to clearly understand new conditions that are likely to be imposed by their lenders.
As Trepp notes in its report, lenders are likely to “tighten belt-and-suspenders legal language when a borrower receives a forbearance or a major loan modification. Lenders are taking this opportunity to tie up borrowers and make any potential future default under the loan painful.”
Traditionally, CMBS loans are non-recourse, though so-called “bad boy” provisions can be added to limit a lender’s liability and to create a “springing recourse” exception, which can convert a loan from non-recourse to full recourse under certain conditions.
Among the typical issues that lenders may use to trigger springing recourse provisions are:
- Insolvency. Springing recourse provisions are routinely triggered when borrowers say they are unable to pay their debts.
- New debt. A springing recourse provision can take effect if a borrower accrues additional debt—this can be true even when a loan is forgivable, like those offered under recent government COVID-relief efforts.
- Property transfers. A lender may ask for a springing recourse carveout that prevents the borrower from transferring property without the lender’s consent. This can include a sale of all or a portion of a property—or if the borrower grants easements or other encumbrances against the property, including concessions to tenants.
CMBS borrowers should proceed with caution and pay close attention to their loan terms to avoid triggering springing recourse and other unfavorable provisions. This is the case even in scenarios where business decisions may seem obvious, or when the landlord is acting in good faith to assist a tenant whose business has been affected by the coronavirus pandemic.
For instance, CMBS borrowers may need to renegotiate a lease with a tenant that is demanding concessions on rents. However, the terms of a mortgage may require the lender’s approval.
Failing to gain this approval could be considered an unauthorized property transfer, thus giving the lender an opening to move the loan from non-recourse to full recourse.
Because of the current uncertainty in the marketplace and the increased risk they face, lenders are likely to try to gain as much advantage as they can, particularly with distressed CMBS borrowers. Borrowers should prepare to spend extra time and effort on decisions that may have an impact on their loans. Not only will they be working through their own decision-making processes, but they will be grappling with the lender’s as well.
Borrowers should also work closely with their counsel, having them review loan terms and advising on the impact of business decisions. Counsel should have a clear understanding of real estate finance and experience in helping clients navigate the complexities of CMBS-related real estate financing.
To learn more about how Kaplan, Voekler, Cunningham & Frank assists clients with real estate financing issues, including CMBS, contact us for a consultation.