The COVID-19 pandemic and related restrictions on travel and public gatherings have particularly impacted the hotel industry. STR, which provides data benchmarking, analytics and marketplace information for global hospitality sectors, reported that as of April 8, 2020, nearly eight out of every 10 hotel rooms in America were empty. Many hotels have closed their doors or dramatically reduced operations in response to the historic drop in room demand or government-mandated closures in certain markets. No one knows how long the pandemic or the related restrictions will last or what will be the long-term effects of the pandemic on the hotel industry. Many hotel owners likely will not be able to make their loan payments for the next several months and possibly quite longer, and many expect a new industry-wide pursuit of stabilization on a scale that has never been seen before.
The hotel industry was among the first industries to be affected by COVID-19, as large gatherings such as conventions and special events were canceled well before other nonessential businesses were closed and stay-at-home orders were put into effect. The impact on the hotel industry has been sudden and severe, and hotel owners have been forced to respond to these unprecedented challenges rapidly. Beyond being a commercial real estate asset, a hotel is an operating business with unique issues and complex operating structures that involves many stakeholders and third parties with contractual rights, including:
- branding and management relationships
- multi-layered equity structures
- interrelationships with residential, retail, office and condominium components in a mixed-use setting
- unit owners in condominium hotel structures
- ground lease lessors, some of whom may be governmental
- vendor relationships
- employer/employee relationships
Only weeks into the impact of COVID-19, many in the hotel industry are facing potential loan defaults. As they respond, hotel owners must keep a wide range of operational issues and stakeholders in mind. For now, it appears that at least some lenders and hotel owners are seriously considering what might be called a "time out" approach to allow time to evaluate the situation before taking drastic steps that loan documents permit but would be in neither party's long-term interests.
Time Out Considerations
Many hotel borrowers have reached out to their lenders for potential debt relief even as such requests are not yet tied to a current event of default. The kinds of relief being considered or granted generally involve one or more of:
- loan payment forbearance and accrual
- reallocation of monetary reserves
- waivers of default for hotel closures and operating covenant violations
- debt service and other financial covenants.
Some lenders have formulated sweeping forbearance approaches, while others, including commercial mortgage-backed securities (CMBS) loan servicers, are taking a loan-by-loan approach. These "time out" agreements permit the lender and borrower a period of time to deal with the issues generated by the COVID-19 crisis, while providing both parties and other various stakeholders an opportunity to gain a better understanding of how best and fairly to deal with hotel assets over a period of time as the industry and the country approach what is likely to be a slow return to anything normal. Although outside of the scope of this alert, it should be noted that there may be tax and accounting ramifications for any forbearance or loan restructuring agreement.
Down The Road
Forbearance may make particular sense in situations where a hotel's cash flow is expected to be temporarily reduced by factors outside of the hotel owner's control in a period where there are industry-wide unknowns, but it may not be a workable solution where the situations have longer-term or permanent impact on a given hotel property or portfolio. The approaches adopted by various lenders in response to the 2008 financial crisis are the most recent example of the hotel industry being put under enormous stress, but that crisis' effects were not as sudden and deep as those being experienced during COVID-19, and they occurred in a much different lending environment than exists today. Perhaps the parties now bring to the table some of the lessons learned during the 2008 crisis as they consider their responses and strategies. As time passes, a better understanding will be gained of what may be the lingering impact of this pandemic on the hotel industry and what further relief may be necessary. Lenders, workout teams, special servicers and hotel borrowers, with their stakeholders, should then be in a better position to formulate a more long-lasting approach to any continuing defaults. For now, though, it appears that the parties could sensibly be taking a "time out" before committing to rushing to exercise contract remedies.
Article originally published on 20 April 2020