Considerations on the Impact of the Novel Coronavirus Pandemic on Real Estate
COVID-19 Legal Updates Juan Zuniga · March 30, 2020
Brad Hunter, managing director at RCLCO, writes in a March 24, 2020 article in Forbes that the effects of the economic slowdown caused by the novel coronavirus are “a serious threat to commerce, profits, jobs, and, ultimately, real estate. The duration of the downturn will be the key determinant of how long and in what ways the real estate markets suffer.” Forbes article.
Beginning with California Governor Gavin Newsome’s shelter at home order on March 19, 2020, millions of American businesses were brought to a grinding halt. Immediately, the domino effect was brought to bear in the commercial real estate sector as tenants had to close their businesses with a resulting steep drop in revenue. Given that rent, after payroll, is one of the largest expenses for a business, tenants began asking landlords for forbearance and extensions with respect to rent payments which, in turn, caused landlords to ask for forbearance from lenders. Unfortunately, as noted by Hunter, the uncertain length of the crisis makes effective management of commercial real estate concerns difficult to manage.
In the past few days, Rimon attorneys have been advising clients on how to negotiate issues arising from COVID-19 and related governmental shut-down orders. Here are some reflections from these early days:
Stay at Home and Shelter in Place orders:
The various State, county and municipal stay at home and shelter in place orders have some basic features in common. First, they encourage businesses to have as many employees as possible work from home. Second, they order that “non-essential” businesses close for operations to the public. Third, employees attending to certain “essential” activities may be allowed to work at the normal place of business. These orders have disproportionately affected certain sectors of the economy including retail businesses, hotels, tourism, entertainment venues, and restaurants. The closure, steep decline in revenue and dislocation caused by these orders are being felt acutely in the commercial, hospitality and office real estate sectors. Empty malls, shopping centers and hotels mean no revenue for the businesses operating in these spaces and work-at-home practices mean office buildings are empty as well, except for certain limited personnel.
Commercial tenants of all sizes are seeking relief from rent payments because of steep declines in revenue. Tenants in these circumstances need to immediately open lines of communication with their landlords to discuss rent relief. Available avenues of discussion between lessors and lessees include deferral of all or a portion of monthly rent due for a specified period of time, use of reserves and security deposits to off-set rents and expenses under leases, and immediate reduction in estimated CAM charges given that commercial establishments will likely have lower common area expenses resulting from less activity. In addition, landlords with NNN leases may consider deferring that portion of rent related to property taxes and insurance for such period as taxes and insurance premiums have been paid.
It is worth noting that many states and municipalities have imposed temporary restrictions on commercial evictions. However, such relief from evictions does not absolve a tenant from its obligation to pay rent. They merely prevent lessors from commencing or pursuing evictions as a legal remedy as well as preventing negative credit report consequences arising from lease defaults caused by COVID-19 related economic consequences. In this regard, California Governor Gavin Newsom issued an executive order allowing local governments to impose eviction protection for residential and commercial tenants who are unable to pay their rent due to the effects of COVID-19. Governor Newsom’s order, however, makes clear that such local ordinances should state that rental payment obligations of the tenant are deferred for a reasonable period but not waived.
Regardless of the outcome of negotiations between lessors and lessees related to COVID-19’s effects on leases, both parties are best served if any agreements are clearly defined and documented in writing. Further, lessors should clearly specify that any forbearance agreed to does not imply an agreement for future forbearance or other concessions. In addition, lessors may want to condition any forbearance on a lessee’s application for relief available under the CARES Act or other SBA relief programs and to apply any proceeds made available to catch-up rent payments.
If potential tenant defaults and forbearance represent the first in a row of dominos, the next domino is represented by the potential for default on mortgage loans by owners of commercial properties. As with tenants and leases, property owners need to open lines of communication with lenders and be open about the need for concessions and deferrals on mortgage payments. With respect to mortgages, property owners may consider asking for:
- Application of reserves in order to preserve cash flow
- Payment of interest only until such time as revenues stabilize
- Forbearance of events of default relating to balance sheet and cash-flow covenants
- Forbearance of defaults related to DSCR, LTV and other similar economic tests and covenants
- Waiver of non-recourse carve-out guaranties related to potential insolvency of borrower caused by COVID-19 economic impact
- Waiver of pre-payment penalties in the event borrowers need to refinance loans under new conditions, including under the lending stimulus programs to be established pursuant to the CARES Act
Lenders will likely require certain disclosures and concessions from borrowers in order to grant any mortgage loan relief, including:
- Updated balance sheets and cash flow statements with details on loss of revenue resulting from COVID-19 and related stay at home orders
- Continued payment by borrower of and maintenance of minimum expenses required to preserve the value of the mortgaged property, including property taxes and insurance
- Borrower’s application for PPP relief which would be applied to mortgage payments as required under the CARES Act
Conclusions: There are no simple and uniform solutions to resolve the current and future impact of the economic consequences to the real estate markets of the COVID-19 pandemic. All players need to understand that the best outcome will result if all parties (lessors, lessees, borrowers and lenders) can survive the crisis without going under. This requires an understanding that if we allow any player to falter, then all players will suffer. Hopefully, in the coming weeks and months as these negotiations play out, all players understanding that cooperation and conciliation will be beneficial to all involved.
Juan E. Zúñiga is an international transactions attorney who has worked on cross-border deals throughout the United States, Latin America and in over 60 other countries. His practice is focused on buying and selling real estate, resort and hospitality transactions, mergers & acquisitions, overseas distribution agreements, international joint ventures, foreign trade and commerce, workouts of distressed assets, lending and investment issues. He has been particularly sought out for his handling of cross-border transactions, especially in Latin America. In this work, he represents American clients in their investments in overseas properties and in establishing subsidiary operations internationally. Additionally, he represents foreign clients in their investments in the United States. Read more about Juan here.
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