In the short-term, real estate investors will be faced with two sides of the same investment coin. Those investors with cash will be able to buy investments that others cannot close on due to the slowdown of the financial marketplace. Those without cash will need to bail out of deals because many of their loan commitments evaporated.
Background: On the 15th of March 2020, in response to unexpected economic implosion due to the coronavirus, in an unusual move for a Sunday, the Federal Reserve reduced interest rates to almost zero. Banks and other financial institutions contemplated that for a week and then decided they would lower interest rates to borrowers to about 3%.
That reduction lasted about a week, before across the country Governors closed pubs, restaurants, and all locations where people could congregate. Those businesses not only laid off staff but also rushed the banks looking for capital to carry them through the crisis. Financial institutions realized almost immediately they had to reallocate their assets and basically closed out lending except for their very best customers.
In the next three months real estate investors can expect the following – there will be fewer property sales due to:
- Lack of property income (since many tenants cannot pay their rent) which makes
properties hard to finance and underwrite
- Marketplace uncertainty
- Lack of available financing and higher interest rates making some deals unappealing to investors
- Lack of property that will underwrite to new standards
- Lack of inspectors to complete due diligence (due to “stay at home” orders, and COVID-19 risk)
- Inspections of units will not be available for sales
- Surveys, level one environmental, structural
- Fewer lenders because some lenders have exited the marketplace
- Projects under construction may have their loans canceled or slowed down
- Appraisers will be unable to deliver appraisals that banks will accept due to marketplace uncertainty
What Deals are Closing?
- Where there are cash buyers, there are sellers motivated to sell.
- Buyers are increasing their down payments, to lower their risk.
- Long term tenants with strong balance sheets will most likely survive a short-term downturn and will attempt to take this moment in time to negotiate beneficial leases, which include “free” rent.
- Buildings with industrial tenants/essential tenants that are not affected by the shelter in place, where the companies have kept working and or the employees have been able to work from home.
In both sales and leasing transactions, buyers and tenants will attempt to extend deals for 120 days or more to wait out the downturn.
Risky Commercial Tenants
Some commercial tenants may not make it through this downturn because they are undercapitalized, were struggling to stay in business already, or their local market was already oversaturated with this type of tenant, (in other words too many restaurants in a small market place).
Nail salons and restaurants spring to mind as a risky tenant, though the innovative ones will recast themselves – while office tenants, medically related tenants, and many industrial tenants do not seem to be as affected.
Interesting fact: According to the National Restaurant Association, nearly 60% of restaurants are for off-premises dining. 90% of current consumers buy takeout at least once a month. 79% order delivery directly from restaurants and 35% order through third-party applications like Grub Hub and Uber Eats. Clearly restaurants are better set to survive this pandemic than say nail salons. (Source: Shopping Center Today Magazine, March 2020 Edition, “Can restaurants make Money from delivery Apps?”)
Tenants may go out of business or choose to renegotiate their leases. Some tenants (that served the public) will need forbearance because the government has ordered their businesses closed. Owners of these businesses will either:
- Go out of business
- Shrink their companies
- Work from home – for an extended period
- Refinance using money appropriated by the CARES Act, which has
funding for small businesses and large businesses
- Get an injection of cash from an equity partner
- Obtain cash from banks – conventional loans
- Restart their businesses with their own cash
The months of April, May, and June will prove to be challenging for the owners of rental homes, mobile home parks and apartments. But money has been appropriated by the CARES Act to help fund unemployed workers and gig workers who lost their income due to COVID-19.
Even though governors indicated that tenants who had no income during the crisis could not be evicted, they left room in their proclamations to allow landlords to collect rent from tenants who were still employed and had no COVID-19 related issues. Additionally, those proclamations typically indicated that rent was still due, albeit at some time in the future.
Those investors who make money with investments in vacation rentals like Vacasa and Airbnb as well as hotel owners are going to suffer the most until traveling is considered safe again.
Landlord Remedies to Deal with Cash Shortfall
Clearly, landlords have difficult decisions to make. If the rents do not come in, then real estate investors will need to tap into their financial reserves. If an investor thinks they might be in trouble, they should reach out to their lender and start working on a forbearance program. There are a wide range of possible opportunities to reset a loan, but landlords need to start the conversation before tenants stop paying their mortgage. Don’t think it will be easy. The financial institutions will want justification to justify the reset of the loan. But they will be motivated to cooperate by state and federal laws* making it easier for borrowers. Be prepared with tax returns, operating reports, and personal financial statements.
Borrowers with federally backed mortgage loans experiencing financial hardships due to COVID-19 are protected from foreclosure for a 60-day period beginning March 18, 2020. The CARES Act further provides forbearance of up to 180 days on such loans. This includes mortgages held by Fannie Mae and Freddie Mac or insured by HUD, the Veterans Administration, or the USDA. The relief expires December 31, 2020, or the date the national emergency is terminated, whichever is earlier.
No additional fees, penalties, or interest will apply during this forbearance if the borrower makes all contractual payments on time and in full under the mortgage terms. Foreclosure is not permitted unless there is a vacant or abandoned property. https://www.delapcpa.com/alerts/the-cares-act-emergency-relief-for-businesses-and-individuals.htm
For the next six-months real estate investors will be facing challenging times as business and residential tenants find their footing. Once that happens, all will be right in the world, it’s just the COVID-19 virus forced us to hit the reset button.
See below for additional information about the CARES Act.
- CARES Act summary of money available for small businesses
- Emergency grants and a forgivable loan program for companies with 500 or fewer employees.
- There are also changes to rules for expenses and deductions meant to make it easier for companies to keep employees on the payroll and stay open in the near-term.
- Emergency grants: The bill provides $10 billion for grants of up to $10,000 to provide emergency funds for small businesses to cover immediate operating costs.
- Forgivable loans: There is $350 billion allocated for the Small Business Administration to provide loans of up to $10 million per business. Any portion of that loan used to maintain payroll, keep workers on the books or pay for rent, mortgage, and existing debt could be forgiven, provided workers stay employed through the end of June.
- Relief for existing loans: There is $17 billion to cover six months of payments for small businesses already using SBA loans.
* New York State has implemented extraordinary measures to lessen the impact of COVID-19. These extraordinary measures include authorizing the New York State Department of Financial Services (NYSDFS) to issue emergency regulations affecting all New York State banking institutions.
Clifford A. Hockley is President of Bluestone & Hockley Real Estate Services, greater Portland’s full service real estate brokerage and property management company. He is a Certified Property Manager and has achieved his Certified Commercial Investment Member designation (CCIM). Bluestone & Hockley Real Estate Services is an Accredited Management Organization (AMO) by the Institute of Real Estate Management (IREM). Cliff is also the author of Successful Real Estate Investing – a book on how to invest wisely, avoid costly mistakes and make money.