Anyone who owns an office building, shopping center or other commercial space has probably seen their property values decrease since the pandemic began. Particularly hard hit are hotels, especially those in tourist areas.
The Financial Times reported in September that values are down an average of 27% with hotels in some areas seeing even larger drops. The article sites a Houston Crowne Plaza hotel which has lost 46% of its value since the pandemic began.
As property values plummet, servicers are ordering new rounds of appraisals. That means that owners still able to make their monthly debt service could still find themselves in default. Banks have been more willing to work with borrowers but CMBS financed loans are a different story.
Even though the average loan to value ratios on CMBS financed loans has been under 60%, servicers are taking action to protect bondholders. Unfortunately, some special servicers have been particularly aggressive. That means defaulting borrowers who are still making their payments.
Courts don’t like so-called non-monetary defaults, particularly for borrowers who have never been late on a payment and still have enough equity in the property to protect the noteholders.
Some of the most aggressive special servicers include LNR Partners and Rialto.
Theoretically, appraisals help special servicers determine how much latitude to give borrowers but in our experience, that isn’t always the case.
Let’s look at a hypothetical to better illustrate the point. Hotel X was valued in 2019 at $13 million and now has a current valuation of $10 million and an outstanding loan balance of $12 million. The loan is clearly underwater and expecting much relief from the special servicer is unrealistic.
Unfortunately, at this point it may be best to carefully simply walk away and avoid any traps that could trigger personal liability.
Now say the loan balance is only $8 million. In theory the bondholders still have a healthy margin of protection.
Many loans require a certain debt to equity ratio. If in our example the borrower must maintain 25% equity in the property, the borrower is in default even though it has never missed a payment.
Why Are Special Servicers So Aggressive?
Traditional banks have a financial incentive to work with troubled borrowers. Helping a borrower fix a problem is often cheaper than risking a forced sale price. As part of the coronavirus relief offered by the government, the IRS and FDIC have relaxed rules making it easier for banks to work with borrowers.
In the CMBS world, a troubled loan is sent to special servicing. There is no bank involved once the loan was sold and packaged into a Commercial Mortgage Backed Securities (CMBS) trust. Unlike banks, special servicers are unregulated. (New York State has recently started regulating the industry.)
CMBS special servicers are obligated to all the bondholders and have less room to negotiate. The real reason for their aggressiveness, however, is much more sinister.
Banks aren’t allowed to hold foreclosed property. They have to sell it. A special servicer, however, can acquire property for its own portfolio. That means special servicers have less incentive to work with borrowers.
Worse, special servicers only get paid when a loan is in special servicing. That puts them in an adversarial relationship with borrowers. The longer they can keep their thumb on a borrower, the more money they make. Because they aren’t regulated, they have more leeway as to what they can charge in fees, default interest, etc.
What Should Hotel Owners Do When in Special Servicing?
The most important thing to do when being assigned to special servicing is to find an experienced CMBS lawyer. That isn’t always easy since many lender lawyers choose to work for banks and not borrowers.
If there is any good news about CMBS loans, it is that most are not recourse. There are hidden dangers in many loans however, so called “springing guaranties” or “bad boy carveouts.”
Close your doors without following proper procedures? You may find yourself personally liable for any deficiency. Ditto if you borrow more money to tide you through the pandemic.
If you are underwater and just want out, a good lawyer can help you do so without becoming personally liable for any deficiency.
Assuming you can keep making payments and want to save the property (and your equity), a good CMBS lawyer can also help you aggressively fight back. That may mean convincing the servicer to allow you to use reserves or avoid a technical default based on ratios.
One trick special servicers like to use is to place you in default and silently accrue default fees. 18 months from now when vacation travel has returned to normal levels you breathe a sigh of relief thinking you made it. That is when the special servicer resurfaces to remind you that you owe $1 million in accrued default interest and special servicing fees.
Have a Conventional Loan on Your Hotel?
If you have a conventional loan on your hotel, negotiating relief with your bank should be much easier. You or your own lawyer may be able to arrange acceptable terms. If not, we are ready to jump in and assist.
Unlike traditional general commercial lawyers, our practice centers on hotels, shopping centers and large commercial projects. We have one of the most robust CMBS practices in the country too.
Values Are Down but There is Hope
No one knows whether there will be another round of forced business closings or not. Over 6 months into the coronavirus pandemic, things continue to change. Each day we get closer to a vaccine and a variety of relief packages have been drafted to help the hospitality industry.
Even though things look hopeless, we have been able to successfully take on special servicers.
To lean more, visit our CMBS workout page. Need help right away? Let us know how we can help. For more information contact us online, by email [hidden email] or by phone, 877-858-8018. We represent CMBS borrowers and hotel owners across the United States.
Mahany Law and Judge, Lang & Katers – Proud Partners with the Hospitality Industry