With tenant downsizing, inflation and rates rising, the impact on commercial real estate property performance is staggering. Just as significant, these factors can trigger defaults in various loan documents. Commercial Mortgage-Backed Securities (CMBS) loans are especially sensitive to major tenant issues where the loan covenants can be brutal.
The economic stress placed on the substantial retail chain Kohl’s is a prime example of how tenants are shifting their operating and occupancy strategies. According to Michael Cohen, Managing Partner at Brighton Capital Advisors, these decisions could negatively impact your loan.
“As a former Regional Director for top tiered CMBS platforms for 25 years, I can safely say that this current turbulent market (post-covid, high inflation rate and Russian invasion into Ukraine combined) was not contemplated when writing the loan documents and covenants,” Cohen said.
CMBS loans are based primarily on a property’s cash flow to pay the debt service and cash reserves in order to maintain and lease the property (or as additional collateral to pay down the loan). A common CMBS loan covenant is centered around Specified Tenant clauses which are typically defined as the major tenants of the asset that is securing the loan.
“CMBS servicer’s have many options at their disposal to remedy perceived problems and in today’s turbulent market they will not hesitate to use them,” Cohen said.
More often than not, any time a Specified Tenant downsizes, has a credit rating downgrade or closes its store (even if they are still paying full rent) will cause the loan to go into a cash flow sweep. In this scenario the Lender gives notice for all tenants to send their rent to a lender controlled lock box account. Once the Lender has satisfied all of the debt service and reserve requirements, all excess funds are swept into an account held by the Lender until the event of default is cured. However, in certain loans, the default will never be cured due to the way the loan covenant was drafted.
Below are possible triggers on your CMBS loan that could cause a cash flow sweep trigger event:
- Failed coverage ratio test from reduced space/shrinking rents
- Termination, non-renewal or downsizing of Specified Tenant
- Rating downgrade of Specified Tenant
- Specified Tenant vacates or goes dark (even if they remain paying rent)
- Co-termination Clauses caused by Specified Tenant action (domino effect)
- Servicer review of rollover reserve potentially causing increase to monthly escrows
- If Specified Tenant self-insures, the downgrade trigger may require the Borrower to obtain replacement insurance.
- Loan put on Servicer Watchlist
- Loan transferred to Special Servicing and immediately incurring fees to Borrower
Unfortunately, CMBS loans are rigid, and the servicer will act on what is specifically in the loan documents without much consideration of current factors unless the Borrower can clearly outline the case for a loan modification.
“It is now more important than ever to improve communication with the servicer. Getting legal advice from counsel is a good start, however, engaging counsel to negotiate with the servicer may leave the business people out of the loop. We suggest contacting banking consultants who have direct knowledge and access to the servicer,” Cohen said.
