In this edition of Coronavirus Q&A, Bilzin Sumberg's real estate leader discussed the current challenges that hotel owners face and the rocky road ahead for that sector.
This interview has been edited for length and clarity.
I know you do a lot of work in the hotel space. What are the major questions you're getting from hotel clients right now?
No one knows when it's going to end. I think that's the biggest challenge, right? No one knows how long this situation is going to be. I think in the very beginning, everyone thought it was a temporary period of time. Maybe a two-month or three-month period of time. We'll shut down, we'll all behave, we'll socially distance and this going to go away in three months. And now it looks like it's not going to go away for a while.
It has a lot to do with what type of hotel you have. I think it's going to be a half-marathon for some and for others it's going to be a marathon. And not everyone's going to make it.
One of the questions that I've been following is negotiations between owners of hotels and lenders. How are you seeing those conversations play out right now, either from the borrower side or the lender side, or both?
I'm in a unique position. I sit in both chairs. We represent a number of lenders and special servicers. It's not a broad brush solution. I know everyone wants it to be a broad-brush solution — everyone doesn't pay their [debt] service for six months, and the world's going to be great. It just doesn't quite work that way. You have to look at each hotel. Those are all unique and you have to look at all the facts and all the circumstances for each hotel. And I say that sitting on the lender side of the table and also on the borrower side of the table, because each one is an operating business and they're just different. They're in different positions.
To the extent that this involves commercial mortgage-backed securities debt — many hotels have CMBS debt — how are you seeing those conversations play out, especially when, maybe, special servicers are involved?
OK, so we've had several different types of requests. And I think one of the misnomers is to get any sort of relief you have to be in special servicing. That's not the case.
The initial type of relief that we were seeing were PPP loan requests, use of reserves to pay debt service or some negative operating expenses. Perhaps a relief where you don't have to pay all of the reserve amounts. Taxes and insurance are kept in a very high position and always would need to be paid, but maybe there's some extra money in a [furniture, fixtures and equipment] reserve. Maybe you don't need to pay into the FF&E reserve. The brands were very quick to relax standards as far as PIPs, or property improvement plans, and pretty much across the board came out and said, "You know, we're not going to require anything during 2020. We know these are tough times. We're just going to do status quo for 2020." So not all of that money had to be used right away so it could temporarily be used for other things. Also some borrowers had asked for relief on debt service coverage tests and different trigger periods and trigger events.
I think there are other hotels — especially those that were struggling before this started, or that other type of hotel where the business just isn't going to come back for a while — that are going to have a lot bigger problems. The select service industry and top part of the hotel industry is able to operate at a minimal cost structure, so they have the least amount of operating costs just based upon the services they offer, based upon their real estate and the physical plan. So they can really cut costs and operate quite efficiently. So those will typically be the first to come back in the cycle. And we'll see transient hotel guests with a little bit of uptick in business travel.
The hotels have done a great job on the hotel owner side and the brands have really done a great job of figuring out how they can operate safely. And they've made a lot of modifications to their physical plan. They've made a lot of modifications to their operational plan and have invested a lot of money in operating in a safe manner. So that's a good thing, and people were able to respond very quickly. I sit on the board of the Greater Miami and the Beaches Hotel Association and I've seen firsthand how the owners have responded, how they've invested in their properties and then kind of adapted to this new era. They had training for their workers. They have testing for their workers. They don't service rooms once a guest is in them. They try to keep everything sanitary.
So if you have the select service hotels coming back first because they're a little bit more nimble, what's the road forward for the other hotels that aren't as nimble?
You know, I wish I had a crystal ball. I'd be the smartest person in the room right now, and I'd make, I'm sure, a lot of money if I could figure that one out. I don't think anyone knows, really. Is it adaptive reuse? I just hung up a conference call with a group of people who were talking about adaptive reuse. I understand somewhere between 6% to 10% of the hotel rooms in Manhattan are closed and they're closed permanently. So the creative developer types or investors are going to be the ones to figure out what to do with that space.
And there's going to be adaptive reuse. There has to be, by definition, right? Because demand is going to take so long to come back, plus you have a new product coming in. So the older hotels are the ones that are really at risk. Now short-term, there's been some very creative adaptive reuse. Everything from leasing hotels for homeless shelters and for first responders, and for people who can't quarantine in their house because they may have small quarters and a multigenerational family living in a small place. Now we're seeing hotels being used as college dormitories.
We've talked about CMBS loans from a borrower-lender discussion point of view, but what's your sense about new issuance of new financing? Are CMBS lenders out there making new loans right now for hotels?
Right now, it's pretty safe to say across the board with any type of lender that the faucet has been turned off for hotel lending. I have yet to see it be turned back on. That doesn't mean it won't. I think you'll see it [be turned back on] for some lenders, likely in the alternative financing sources and [for] bridge loans on a temporary basis, because no one can really predict the future. And these alternative financing sources are going to be a lot more expensive than a CMBS product or more expensive than a community bank product. So new lending is going to take awhile. I just have not seen it yet. I have seen new CMBS issuance, but those new pools did not have any hospitality product in them.
I'm wondering, I guess, about the question of underwriting these new loans. Underwriting must be a nightmare for CMBS lenders right now.
It's all about people trying to predict the future, right? [When underwriting COVID-19 issues], you can't look back on historical [data, as the real estate world typically does]. So, in the real estate world, we look back on historical. We look on a trailing six-month period of time and a trailing 12-month period of time. We can analyze out certain factors. We could factor in certain trends or blips or a hurricane. With this, it's a pure guess. Had you asked me six months ago would 50% of the hotels in the United States be closed, I would have told you you were crazy. Absolutely, positively crazy. And lo and behold, we had that, come March. So you're really guessing at future revenue.
Now I think some of it can be underwritten. I've stayed in hotels since March. I've stayed in a couple different ones and I felt safe. I didn't have any issues as a consumer. I altered my behavior in the hotel, I'll say that. I was very careful about what I touched and who I came in contact with, and I washed my hands a lot more. But [in terms of] instilling consumer confidence, I mean, people will travel. It's just how much and how safe they feel. It's the business travel that's cut off. Now one stat I heard which was kind of interesting is you won't have the one-day business trip anymore. You'll have probably a longer trip and [the trips will] be less frequent.
I wanted to ask you about force majeure. A lot of people start talking about force majeure in March and April. Now that we're here in August, what do you think we've learned about force majeure and how do you see it changing the future or applying in the present?
The devil's in the details. The force majeure clauses really really depend on exactly how they're written. Now, I've seen force majeure clauses in leases and construction contracts and those types of things. When it comes to paying money back, the force majeure provision typically doesn't apply. The force majeure provision typically does not apply to the payment of money.
But whether you have to meet certain milestones and different types of things, that's traditionally how force majeure has been used. Now, in negotiating leases and things like that, I see how the definition is changing. The retailers are probably the first out of the box to try and get the definition of force majeure changed, and their goal is, if they can't open because of some sort of governmental order or pandemic or something like that, they don't want to have to pay rent. I understand the position. But when you're looking at it from an owner standpoint and a lender standpoint, that's something that's really hard to underwrite. How do you underwrite? Do you just loan less money? I don't think anyone's really solved that puzzle yet. But people are definitely looking at them and definitely looking to change them to take into account what happened. Especially when there's a governmental order for an extended period of time where everyone has to shut down. Pandemic, every once in a while, was in a force majeure clause. I bet you'll see it in a lot of them now.
*This article was republished with permission from Law360.*