In response to the (hopefully) once-in-a-lifetime havoc wreaked by the COVID-19 pandemic, President Trump signed the CARES Act into law on March 27, 2020, offering sweeping relief to Americans in many facets of daily life. While failing to secure universal assistance for all those living in rental housing, the Act does provide a safety net for the millions of renters whose property happens to have financing assisted by the federal government. In this article, we’ll explore key takeaways from the CARES Act related to lenders, borrowers and residents who participate in HUD’s housing programs. We’ll also highlight some important questions raised by the Act, questions that HUD guidance or subsequent legislation will need to address.
The CARES Act allows certain borrowers to request and receive forbearance on their mortgages for up to 90 days. Section 4023 of the Act allows owners of properties with “federally backed multifamily mortgage loans” who experience financial hardship directly or indirectly because of COVID-19 to request a forbearance for up to 30 days, which can be followed by two successive extensions of 30 days each. The Act states that upon receiving a request for forbearance, a lender “shall . . . provide the forbearance” (emphasis added). (See Question Mark no. 4 below, on whether lenders should push back on claims of financial hardship).
Section 4023 applies to any “federally backed multifamily mortgage loan,” a broadly defined term. This covers all loans that (i) are secured by a permanent lien on residential multifamily property designed for at least five families and (ii) are “insured, guaranteed, supplemented, or assisted in any way, by any officer or agency of the Federal Government” (including HUD-insured loans) or are “purchased or securitized by” Freddie Mac or Fannie Mae. In addition to the financial hardship requirement described above, an owner must also have been current on payments as of February 1, 2020.
As a condition of receiving the forbearance, owners must provide certain tenant protections. For example, owners may not evict or initiate evictions of tenants solely for nonpayment, nor may they send notices to vacate or charge late fees or penalties for late payment. These restrictions apply for the period of forbearance which, depending on when an owner requests forbearance, will likely overlap with the 120-day eviction moratorium described below.
The CARES Act also puts an eviction moratorium in place for 120 days after passage of the Act. Section 4024 of the Act provides that until July 24, 2020 — 120 days after passage on March 27 — owners of certain properties (as defined below) may not evict or initiate evictions of tenants for nonpayment of rent, nor may they charge fees or penalties related to nonpayment of rent. Additionally, owners may not issue a notice to vacate until the end of the 120-day period, and even then must give at least 30 days’ notice. For tenants, this stretches the moratorium to at least 150 days. This moratorium applies regardless of whether an owner requests the forbearance described in Section 4023.
The restrictions described above apply to owners who fall into at least one of two categories. First, an owner could be a participant in either the rural housing voucher program or in one of the housing programs defined in the Violence Against Women Act (VAWA). VAWA housing programs include Low-Income Housing Tax Credit (LIHTC) properties, public housing, both the Section 8 Housing Choice Voucher (HCV) program and project-based Section 8 properties, and many others. Although there is no formal guidance, it appears that the eviction moratorium would apply only to units occupied by voucher holders and not to an entire project.
Second, the restrictions above also apply if owner has a federally backed mortgage loan or federally backed multifamily mortgage loan. Federally backed mortgage loans include federally insured homes for one to four families. Federally backed multifamily mortgage loans include the same types of properties as the multifamily mortgage forbearance section. So, multifamily properties with loans insured by HUD, or purchased or securitized by Fannie or Freddie, are covered too.
Properties that fall under HUD’s Section 232 “LEAN” program are subject to the forbearance and moratorium provisions. In typical HUD parlance, skilled nursing and assisted living facilities are not classified as multifamily, which might lead us to believe that healthcare facilities are outside the scope of the CARES Act. However, the Act is a product of Congress, not HUD, and Congress defined the term “federally backed multifamily mortgage loan” such that it covers more projects than we might expect. Specifically, the term covers loans to properties that are “designed principally for the occupancy of 5 or more families,” which would include Section 232 healthcare facilities. Given the extra costs owners of these facilities are surely incurring to protect their vulnerable populations from COVID-19, the forbearance provision may be especially helpful.
Let’s imagine a 100-unit multifamily project with a conventional mortgage from a local bank and a Section 8 Housing Assistance Payments (HAP) Contract covering 50 units. Roughly 15 of the unassisted tenants have lost their jobs due to the COVID-19 emergency, putting the owner’s ability to pay its mortgage debt at significant risk. Does the owner qualify for forbearance? And will the unassisted tenants benefit from the eviction moratorium?
Forbearance under Section 4023 of the Act only benefits projects with federally backed mortgages. We might not initially think of the mortgage on this property as federally backed because it came from a conventional (i.e., non-FHA/Freddie/Fannie) source. But as previously mentioned, the Act defines the term “federally backed multifamily mortgage loan” broadly. The term encompasses any loan that
is made in whole or in part, or insured, guaranteed, supplemented, or assisted in any way, by any officer or agency of the Federal Government or under or in connection with a housing or urban development program administered by the Secretary of Housing and Urban Development . . . .
(Emphasis added). The loan in this hypothetical may not be HUD-insured, but it is assisted (albeit indirectly) by HUD through the HAP contract. We therefore suspect that the owner would be entitled to forbearance.
As to whether the unassisted tenants would be protected under the eviction moratorium, we noted above that Section 4024 of the Act applies not just to projects with federally backed financing, but also to properties whose owners participate in VAWA programs. VAWA properties include those with project-based Section 8 HAP Contracts. Since this hypothetical project is covered by Section 4024, everyone residing at the property would be entitled to eviction protection during the statutory period, regardless of whether they receive subsidy under the HAP contract.
HUD differs from lenders, borrowers and residents in that the agency has no specific role to play per Sections 4023 and 4024 of the CARES Act. Similarly, the statute grants HUD no explicit authority to promulgate implementing rules. Accordingly, lenders and borrowers will initially fashion forbearance agreements without federal oversight. However, we expect that HUD will soon seek to assert some control over the situation by publishing guidance clarifying salient aspects of the Act and possibly offering sample documents for program participants to utilize. Faegre Drinker will carefully monitor HUD’s response to the Act and provide clients with advice that takes HUD’s positions into account.
Suppose a lender applied to HUD for a Section 223(f) firm commitment on March 1, 2020. The project’s financials were stellar upon entering HUD’s queue, but by the time the proposed deal goes to loan committee on April 15, many tenants have gotten behind on their monthly rent due to COVID-19-related incapacitation or loss of employment, putting the debt service coverage ratio in a tenuous state. Will HUD approve the lender’s application based on the numbers submitted at the time of application? Or will they look to the lender to provide updated financials?
What about the lenders that received their firm commitments shortly before the COVID-19 emergency declaration and subsequently see their clients’ projects experience financial hardship due to the crisis? Are they at risk of HUD pulling the plug on their deals? Will HUD stand by those commitments to projects that might need forbearance as soon as they enter the FHA portfolio?
We don’t pretend to have solid answers to any of these questions. However, one document that will likely come into play in these scenarios is the Lender’s Certification of No Material Adverse Change. Here’s the relevant firm commitment condition:
No Material Adverse Change. Prior to Endorsement, the Lender must certify that there has been no material adverse change to the: (a) underwriting assumptions stated on the attachments to this Commitment; (b) financial condition or creditworthiness of the Borrower, or principals thereof; (c) Borrower's ability to perform its obligations or responsibilities under the loan documents; or (d) Project; and no event has occurred, or circumstances exist that may result in such material adverse effect.
It strikes us as probable that some lenders will be not be able to furnish this certification prior to endorsement because of rent delinquencies caused by COVID-19. From a purely legal standpoint, HUD would have the right to abandon those deals. Whether HUD would assert that right remains to be seen. Even if HUD doesn’t nix a deal entirely, we anticipate that the agency may impose new conditions to the commitment (e.g., a debt service reserve escrow) in exchange for not requiring the traditional Certification of No Material Adverse Change.
Once a lender receives a request for forbearance from a struggling borrower, the CARES Act requires the lender to “document the financial hardship.” The verb “document” is left open to interpretation. Can the lender require the borrower to substantiate the financial hardship through a detailed narrative and/or evidence that tenants have lost their jobs or been incapacitated?
We note that the statutory obligation to document financial hardship runs to lenders, not borrowers. Furthermore, section 4023(b) of the Act provides that a borrower’s request for forbearance can be “oral or written.” We would therefore advise lenders that they should not condition their forbearance on borrowers providing evidence of residents’ employment termination or any other written evidence of hardship.
Lenders may (and should) collect information from borrowers that is sufficient to create a written record of the need for forbearance. But at the end of the day, if a borrower can make a cogent claim of financial strain, the lender should take the borrower’s word for it and not “push back.”
This, to us, is the million-dollar question, the answer to which will ultimately determine how successful these sections of the CARES Act will be. If forbearance and the eviction moratorium are premised on owners giving tenants a break (i.e., eviction protection), and lenders, in turn, must give borrowers a break (i.e., forbearance), will GNMA security holders give lenders a break?
Forbearance and eviction protection are now statutory rights in the short term. By contrast, the Act does not provide lenders relief from security holders whose investment depends on a reliable stream of mortgage payments. And it’s not as though a lender that is required to forbear can go to a single security holder and request such relief. While a single loan typically results in a single GNMA security, that security will likely get bunched together with other mortgage-backed securities to form a REMIC, slices of which get sold to multiple investors. Given the fragmentation and complexity of mortgage-backed security ownership, we do not anticipate that the private sector will be able to work these conflicts out on its own. Congress will need to impose some sort of holistic solution if forbearance and the eviction moratorium are to have their desired effect.
The Act does not explicitly answer these questions in relation to multifamily mortgage loans. By contrast, Section 4022 of the Act, which covers single-family mortgages, provides the following:
During a period of forbearance described in this subsection, no fees, penalties, or interest beyond the amounts scheduled or calculated as if the borrower made all contractual payments on time and in full under the terms of the mortgage contract, shall accrue on the borrower’s account.
We find the distinction between the single-family provision and the multifamily provision on forbearance to be instructive. Since the Act does not prohibit multifamily lenders from charging fees and penalties as it does for single-family lenders, our interpretation of the Act is that fees and penalties are permissible components of multifamily forbearance agreements, in addition to the accrual of interest.
The CARES Act will undoubtedly provide a financial shot in the arm to some renters and borrowers who desperately need it to make ends meet over the next several months. HUD-insured lenders and GNMA investors may have tough sledding ahead depending on the market demand for forbearance and eviction relief. Faegre Drinker stands prepared to draft forbearance agreements and provide other counsel to HUD program participants to help them meet their obligations under the Act.