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SBA, PPP, Covid-19 and the Rent’s are Due…the Current State of CRE.

Are businesses looking for space to lease?

I’m sure you have all had the question this week either for yourselves or from businesses you work with… “What is going to happen?”

It’s no secret that this crisis has deeply impacted many businesses and their ability to operate in the current environment.  Predictions stem from the dire to the optimistic, but the harsh reality is that no one really knows when we will start to see some normalcy return.  

We want to offer an overview of the CARES Act and it’s effect on the commercial real estate industry. CARES is a $2T stimulus bill designed to help businesses (and individuals) stem the tide that was recently passed by the federal government. Because of the current crisis, the market landscape of commercial real estate has been drastically affected, so we are going to dive into some advice on how to handle this as a tenant and a landlord as well.

So what does the CARES Act even mean for small businesses/tenants?

The CARES Act provides a series of loan availabilities, funding, grants and potential relief for small businesses that qualify across the United States. The primary difference between the CARES Act and pre-existing Small Business Association (SBA) loan programs is the Paycheck Protection Program (PPP), which is a massive expansion of the normal course of SBA lending. 

SBA programs like 7(a), 504 and Express have had varying degrees of success and availability to small businesses since their inception, but the PPP is a new Section 7(a) program designed to help small businesses keep their workers employed by providing financial support through June 30, 2020 for payroll and certain other expenses. Because the PPP removes many of the friction points and requirements that are normally in place, it’s likely that you’re eligible to receive funds if they are being used primarily to keep people employed. 

The PPP significantly expands the SBA’s Section 7(a) lending activities to include (among others):

  • 100% guarantee of PPP loans
  • Waiver of certain collateral and personal guarantee requirements applicable to other types of Section 7(a) loans, short-term forbearance
  • Loan forgiveness.

Note: Here is How to Apply.

So What About Loan Forgiveness?

Loan forgiveness is the tricky part. A smart business will do everything possible to make PPP more of a grant than a loan so they don’t have to pay it back. According to Chapman Insights:

“As an incentive to retain employees or rehire laid off employees, the CARES Act provides that certain portions of a PPP loan may be forgiven. Subject to certain conditions, businesses are eligible for loan forgiveness equal to the amount of payroll costs (using the same definition used to determine loan eligibility) and certain mortgage interest, rent, and utilities payments that are incurred during the 8-week period after the loan origination date. If a PPP loan has a balance remaining after any loan forgiveness, the SBA will guarantee that balance. 

The loan forgiveness amount of a PPP loan cannot exceed that loan’s principal amount and any loan forgiveness amount will not be treated as gross income for federal income tax purposes.

To further incentivize retention of employees at existing salaries, the amount of loan forgiveness calculated above will be reduced if there is a reduction in the number of employees or a reduction of more than 25% in salaries paid to employees. If a borrower reduced the number of employees or salary levels between February 15, 2020 and 30 days after enactment of the CARES Act, those reductions will not decrease the amount of loan forgiveness if the borrower restores the number of employees or the salary levels by June 30, 2020.”

Simply put, that means your loan will be forgiven if you use 75% of the funds for payroll and keeping people employed then submitting the relevant documents. There are a ton of additional standards that have been relaxed and you can loan up to 2.5X of your normal payroll.

Note: Be prepared to provide the documentation on your financial condition along with normal payroll. 

This is a mess for small businesses, what more can the government be doing to help? Are there non-PPP options?

The government needs to put more power in the hands of local organizations and community funds to move money faster, and get it into the hands of businesses within a week. Community funds don’t have the red tape of the SBA and often have a line to the smallest and most at-risk businesses (those with fewer than 10 employees).  Banks being overwhelmed by applications, Bank of America has seen over $30B in loan requests in 4 days, so giving local funds the opportunity to execute makes sense to us.

There may be non-PPP options for you as well, this is a good link on how to access additional resources.

So what does this mean for property owners/landlords?

Well, I hate to say it but I don’t think the CARES Act is great for our industry. It’s great for businesses and employees for sure, which may be the best thing to focus on right now anyway. However, this bill, and the PPP program in particular, actually disincentivizes using the majority of the money loaned for rent. 

Hold on, what?

Yes, if a business uses 75%+ of these funds for payroll then the loan can be forgiven and why wouldn’t they? A smart business should be using that money to keep people employed and not create an obligation for themselves.

What about that last 25%?

Sure, they can pay rent with that, and some will, but because rent is usually a hefty number on a businesses’ OPEX and because the PPP program is telling people they can get this money for free if they use the majority of funds for payroll, then that is definitely where businesses will utilize their cash.

Where does that leave landlords?

Landlords are in a tough spot.  Despite residential government orders to “not charge rent” or to “cancel evictions,” these orders likely won’t work broadly with commercial properties (although we could still see them). People would rather often believe that there is this bitter relationship between tenant and landlord and this crisis just brings that to a head. I don’t believe that.

Landlords are really like partners in these tenant businesses. Often they are writing enormous checks and taking on big risks to put a tenant into a space in the first place. Yes, there is a negotiation but that’s normal business. Believe it or not, landlords want their tenants to succeed! If they don’t, they have a problem.

How big is this problem?

Well, it’s a pretty darn big one. Over 90% of commercial real estate has debt on it. Yes, that means the landlord has a piper to pay too. We’ve talked to 50+ landlords this week and almost all of them have the same opinion. Their tenants’ rent are due because their expenses are due. 

Landlords are not only responsible for debt on properties but common areas, maintenance, repairs, improvements, management and more…Tenants usually pay for this through their CAM or Expense portions of their rent. 

As of today, landlords have not seen any relief from their lenders or the government. They have not seen relief for common area maintenance and janitorial services or the many other things (like insurance and electricity) that go into the operations of an asset. Without relief, their bills pile up too.

This sounds like it could be a serious problem.

It does and it is. If businesses are not being incentivized to (and are otherwise unable too) pay rent, we’re looking at a cascading effect of defaults from the bottom up. Unlike 2008 where the top (i.e. banks) failed, this crisis has unfairly impacted otherwise fine businesses who normally paid rent. It’s admirable that the government is helping them, however I think in order to avoid a cataclysm for the CRE industry (which accounts for about $15T in value) we’ll need to see the following things immediately: LENDERS NEED TO PROVIDE RELIEF.

The bottom line is landlords need relief from their debt obligations so they can “not require” rent in these leases. Whether this is 90-day deferrals, forbearance or some other method.  Hopefully three months does it.

If lenders aren’t playing ball nicely and being creative (and they should since we taxpayers bailed them out last decade), then the government should create an order to force them to provide that relief. If the top of the chain (lenders) provides this, we will avert a crisis and see businesses and landlords survive en masse.

If they don’t, then we need to get ready for years of protracted default, lawsuits, and predatory lending/buying as these assets fall into desperate times.

The commercial real estate industry is not difficult. Put simply, it relies solely on income from tenants to survive. That income pays the bills for debt operations and yes, profit. The idea that buildings are printing money is just not true. Most returns for commercial real estate (on improved investment class assets) are 5-15% per year. Hardly a “VC” or crazy-return. CRE is a solid, cyclical asset class that is typically a hedge against volatility. 

If we don’t help landlords here, they can’t help tenants. That could lead to a ongoing nightmare and could pave the way for a litigation bomb – which may occur either way.

So what do we do, right now?

What everything comes down to is that businesses and landlords must work together.

If you’re a business, communicate with your landlords, especially if you’re having hard times due to this crisis. Provide them with actionable information on how the crisis has hurt sales and revenue so they can use that as ammunition on their lenders. Strive to work together and remember that there is a chain here and it’s honestly not antagonistic – it’s actually symbiotic. Tenants and landlords need each other to be successful.

Honest communication, creative thinking and pressuring lenders to provide relief is what has to happen for us to survive. Don’t send a petition to your landlord, send one to the lender. Don’t know who it is? I promise your landlord or management company will tell you. If not, petition the local government for this relief.

If you’re a landlord then lean hard on your lenders; they are your partners too. Defaults serve no one (except maybe the predatory special servicers on CMBS debt) and in short order we have seen most lenders get creative (at least on the phone).

However, we need formal solutions and fast. CRE, unlike housing, is super decentralized in terms of decisions on assets. Most properties have a different owner, debt structure, partners etc… so lenders are likely overwhelmed, that’s without even considering how under water they are from PPP! We still need them to help out…and soon.

I’m advocating for portfolio-wide relief in the short term to assist landlords and businesses, you should too.

This article includes some useful links for you to peruse as it relates to the SBA, PPP and the market landscape of CRE, along with some critical resource guides we have written in the past weeks to help. 

If you need us, whether it’s just advice or it’s to free up some capital for your business by getting your deposit back from a landlord we are here to help. 

Stay safe, stay healthy and we will persevere.

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