As most hotels in the U.S. fight for their lives in the economic crisis caused by the coronavirus pandemic, owners with businesses tied to CMBS debt face an inflexible wall of lenders who cannot provide payment deferments or other forms of relief. Congress is heeding the hotel industry’s cry for help and advocates hope a $10 billion proposal will make its way to federal financial regulatory bodies.
Last November, the Mortgage Bankers Association released a 22-page white paper that explains the role commercial mortgage backed securities – or CMBS – loans play in the commercial real estate industry.
CMBS financing “involves details and nuances that could fill volumes,” reads the first page of the report.
Nine months later, hotel owners may be writing the final chapters of their business story as the coronavirus pandemic and subsequent economic downturn has pitched the CMBS lending market against debtors who are falling behind on their mortgage payments.
Out of the $300 billion in CMBS loans in the U.S., hotels comprise $86 billion in debt.
Trepp reports that payments were missed in April, May and June. The largest number of missed payments were tallied in June. At the end of the month, 20.5 percent of all lodging CMBS loans were in special servicing, up from 16.2 percent in May.
Trepp recently reported in June the delinquency rate on CMBS loans among the different commercial real estate asset classes. Hotel loans account for most of the late payments.
All CMBS loans are managed by master servicers who collect the monthly mortgage payments. The four major servicers are Wells Fargo; Midland, a subsidiary of PNC Bank; KeyBank; and Berkadia Commercial Mortgage. There are also eight special servicers, which get involved if a loan gets into trouble.
A CMBS special servicer does not get involved in a distress situation until a payment is missed.
While many in the hotel industry might believe the financing structure is only for sophisticated large hotel deals, the loans have enabled thousands of owners to build select-service branded hotels in secondary and tertiary markets, where conventional lenders might not want to do business.
CMBS loans were created in the 1990s for commercial real estate transactions. The hotel industry has turned to the structured finance tool in earnest for the past decade.
CMBS EXPLAINED: In a white paper released in November, the Mortgage Bankers Association explains the course of a commercial mortgage backed securities – or CMBS – loan. In a CMBS transaction, commercial mortgage loans are pooled into a package, which is transferred to a trust. The trust issues a series of investment bonds which are divided into classes, which pose different levels of risk for investors who make their money on the interest and principal generated by the securities.
Hoteliers have used CMBS loans for new-construction projects that range around $10 million and up. They’ve also turned to the financing solution to fulfill multi-million-dollar property improvement projects mandated by the brands.
His company owns eight hotels, two of them carry CMBS debt. One is a $10 million TownePlace Suites by Marriott, which opened two years ago. The other is a Holiday Inn Express, which recently underwent a $1.8 million PIP to conform to “Formula Blue,” a redesign mandated by brand parent InterContinental Hotels Group.
“It’s been a very challenging time for us,” Vimal said. “In the first quarter, the engine was running at 100 miles per hour and in mid-March everything was grounded. Businesses, groups and the corporate accounts disappeared overnight. Occupancy went into the single digits within a week. In April and May, occupancy hovered around the mid-20s. We’ve had trouble paying our bills.”
LISTEN: CMBS DISTRESS: Episode 278 of Lodging Leaders podcast covers the current state of the commercial mortgage backed securities or CMBS debt owned by thousands of hotel owners – many of whom are now seeking seek relief as a result of the economic crisis caused by the coronavirus pandemic.
Q Hotels has financed other hotels at conventional banks, local institutions that have had a long-time relationship with Vimal and his business. These lenders agreed to defer mortgage payments for up to three months.
“We were very fortunate with the local lenders,” he said. “But our biggest challenge has been with the CMBS lenders. They have refused to do any kind of deferment and relief.”
Negotiating relief is not an option in the CMBS world. This means thousands of hotels may soon go into mortgage default and the industry may experience a record level of foreclosures this year.
Trepp reports that at the end of June the overall CMBS delinquency rate was more than 10 percent. Hotel loans account for one quarter of that and most of those are in the hands of special servicers, agents who manage delinquencies on behalf of the CMBS bond holders.
Q Hotels of LaPlace, Louisiana, had completed a $1.8 million renovation of its Holiday Inn Express in LaPlace. The lobby was part of the hotel’s transformation into the Formula Blue redesign mandated by brand parent InterContinental Hotels Group. Vimal Patel, founder and CEO of Q Hotels, said the project was financed through a CMBS loan.
In March, Vimal contacted Wells Fargo Bank, the master servicer of his company’s CMBS debt, and asked to talk to someone about his situation. Soon after, he received a letter from the bank informing him he had to comply with the loan agreement.
Adding to the problem, CMBS contracts prohibit additional liens on the asset. That means the business in Vimal’s two hotels cannot receive funds from SBA’s Paycheck Protection Program or its Emergency Injury and Disaster Loan program.
Just to talking to a special servicer will cost Vimal about $7,500. In addition, he faces up to $20,000 in fees if he attempts to work out a solution with the special servicer.
Losses Adding Up
Since the beginning of March, the hotel industry has lost more than $40 billion in room revenue. Hotels continue to lose $400 million every day, according to STR and Tourism Economics.
STR recently reported the industry will not return to pre-pandemic levels of business for three years.
The shift in fortunes has led a group of hoteliers to form a venture that will help owners navigate their businesses through the maze of delinquent debt.
Ash Patel, CEO of Southwest Hospitality Management in Arizona, last month announced the formation of Iridescent Hotels, a third-party manager for under-performing properties and hotels with distressed debt, including CMBS loans in special servicing.
He calls the amount of CMBS loan delinquencies “phenomenal.”
“It was shocking to see the amount of delinquencies in March, amount of delinquencies in April, amount of delinquencies in June, and they kept going up and up. And from that perspective we started researching and looking at the number of hotels that were already headed toward special servicing and this was in the thousands. We’re talking between 4,000 and 5,000 hotels.”
Trepp’s online report in June on CMBS delinquencies shows hotel loans have the most delinquencies.
Patel is CEO of the new company. Raj Chauhan is co-founder and chief technology officer. They are joined by Tim Walker, president and owner of TemperaturePro, an HVAC company with a background in hotel management, and Gary Mills, former vice president of real estate at NewcrestImage.
Though Congress is expected to promote a regulatory solution to the CMBS loan crisis, Ash and his cohorts at Iridescent Hotels believe owners will need help in managing their distressed hotels into viable businesses again.
Vimal Patel and hundreds of other hoteliers are asking the federal government to come up with some form of relief for CMBS debtors. Also lobbying for relief is AAHOA and the American Hotel & Lodging Association.
The associations recommend that as part of the Main Street lending program, the U.S. Treasury and the Federal Reserve create a $10 billion relief fund that gives qualified CMBS debtors a loan equal to a year’s worth of monthly mortgage payments.
The credit program will allow debtors to stay current on their CMBS mortgage payments and prevent the crisis from rippling out to other areas, said AHLA and AAHOA.
LISTEN: SEEKING SIGNS OF RELIEF: Episode 264 of Lodging Leaders podcast on April 10 examines the effectiveness of the SBA rescue package for hotels and what was being done to help CMBS debtors save their businesses from default.
NewGen also has been actively lobbying representatives of Congress for help. To garner attention on the CMBS issues, NewGen formed a group called HOTELS Together; the first part is an acronym for Hotel Owners Together with Employees and Lenders.
“There’s been a lot of movement and work in the background in last two months but there hasn’t been really any finish-line event for getting included into one of the existing government programs,” said Girish Patel, principal and managing director at NewGen Worldwide.
Part of the work to gain attention and subsequent action from the federal government has included hoteliers contacting Congressional representatives and sharing their stories. As lawmakers learn about and begin to understand the plight of hoteliers holding CMBS debt, they have taken action.
In early April, three Republican U.S. senators – Martha McSally of Arizona, Thom Tillis of North Carolina and Cory Gardner of Colorado – sent a letter to Steven Mnuchin, secretary of the Treasury; Jerome Powell, chairman of the Federal Reserve; and Jay Clayton, chairman of the Securities and Exchange Commission asking them to “swiftly issue guidance and relief” to CMBS servicers.
The senators wrote that while nearly every CMBS debtor is suffering financial setbacks caused by COVID-19 outbreak, the hotel industry is especially challenged.
“Every day hotels are closing and more employees are left jobless,” they write.
CMBS servicers need guidance from on high to work with borrowers and navigate the crisis.
After the letter was issued, NewGen witnessed a groundswell of hoteliers contacting their representatives in Congress to tell their stories and explain the hotel business.
Additional lobbying efforts by AAHOA, AHLA and NewGen’s HOTELS Together group pushed the issue to the forefront.
On June 22, a second letter by U.S. Rep. Van Taylor, a Republican in Plano, Texas, asking for a CMBS relief plan was sent to Treasury Secretary Mnuchin and the Fed Chairman Powell.
This time, the letter was signed by 105 representatives of Congress.
Many of the Congressional representatives have talked to leaders at the CRE Financial Council, a trade association and government-lobbying group, Girish said.
It’s key that lawmakers have the support of CREFC before proposing any CMBS relief measures. But he stresses it is the hotel community that has done the hard lobbying for a solution. “These congressmen aren’t proposing a solution because CREFC reached out to them; they’re doing it because hoteliers reached out to them.”
Kyle Walker, CEO of NewGen Worldwide, said transparency is the biggest problem with the CMBS market. In most cases, borrowers seeking help have no idea on the steps or what the costs may ultimately be in seeking forbearance.
Oftentimes, just alerting the CMBS lender that you may have difficulty in making a monthly payment will put your mortgage into special servicer limbo.
“You’re in special servicing because you have defaulted, and usually it’s a default of 60 days, which is almost sure to get you into special servicing,” Walker said. “But on the other side, reaching out and having a conversation and providing the story and providing projected financials will make them look at that and say, ‘This is at risk of imminent default.’ And as a result they can hold you in special servicing.”
Girish said besides approving emergency funding, federal financial leaders need to allow CMBS lenders to create a “technical default,” which recognizes a debtor’s inability to meet debt-yield ratio requirements. “We are trying to avoid defaults and foreclosures by getting loans and we don’t want to get right back into the situation because we forgot to cover these other aspects as well that are all part of this complicated web.”
Both Patel and Walker say the upside of all the trouble is the CMBS market may develop a loan program that uniquely serves the hospitality industry.
After all, there is no other commercial real estate asset class in which the borrower owns the property, owns the business inside the property and operates the business, including hiring employees.
“I think that’s the important thing,” Walker said, “where CMBS came from and where it’s going.”
CMBS was created in the 1990s to address liquidity issues, he said. And CMBS 2.0 emerged from the Great Recession. “There were some modifications from the first CMBS structure to learn from that last recession.”
Here on out, he said, is what happens post-COVID-19, especially if the crisis triggers a deep recession. “Does that trigger a CMBS 3.0? What else emerges from this world of structured finance? Unfortunately, with so many of these financing vehicles the incentive structures within it are set up to originate and churn loans.”
Walker said he hopes the hotel industry does more than write letters to Congress and gets deeply involved in restructuring commercial real estate lending.
Over the past few months, he said, “We’ve watch hotel owners become a little bit more sophisticated in telling their story; we’ve seen hotel owners get more engaged in the political process to make sure they’re being heard. And my question is: Does this prompt hotel owners and people with deep hotel expertise to get engaged in the financial side of the aisle, so to say, and be a part of that structured finance innovation?”