The COVID-19 (coronavirus) pandemic has pushed the U.S., and the rest of the world, into an economic recession. All stakeholders in the real estate market – lenders, borrowers, landlords, and tenants – will suffer consequences, and many, severely.
To help those who are affected understand and respond to the impacts, this article reviews the current state of the real estate market as it relates to the quickly evolving crisis, as well as where the market is likely heading. It also examines the events of the last recession to learn from history and applies lessons to strategic legal planning moving forward.
We are already feeling the chain reaction of massive unemployment, with over six million claims filed in a recent week (doubling the record set the previous week), lost business revenue, tenants failing to pay the rent and borrowers unable to pay their mortgages.
As with the last recession, the federal government has passed legislation and taken initiatives in response to the economic crisis. The recently passed CARES Act provides trillions of dollars of economic relief for consumers and businesses.
All business owners, in real estate and otherwise, should take advantage of the federal relief offering. Widerman Malek is helping our small business clients get their share of grants and business loans the government has made available. Through the Small Business Administration (SBA) Economic Impact Disaster Loan program, business owners can get a $10,000 grant and 30-year loan at a fixed rate of 3.75%. For more information about this and the other government relief options for small businesses, please click here.
For the real estate market, federal agencies have issued directives to relieve mortgage borrowers.
March 18: The Federal Housing Finance Agency (FHFA) and Department of Housing and Urban Development (HUD) announced initiatives to help distressed residential borrowers. FHFA controls Freddie Mac and Fannie Mae, government-sponsored enterprises (GSE) who purchase and back a mortgage debt portfolio exceeding five trillion dollars.
In response to the COVID-19 emergency, FHFA suspended foreclosures and evictions for all GSE-backed single-family mortgages for at least 60 days. Similarly, HUD suspended foreclosures and evictions on all Federal Housing Administration-backed mortgages for 60 days.
Previously, FHFA announced that the GSEs would give payment forbearance to borrowers affected by the crisis. This relief allows borrowers to suspend payments for up to 12 months due to Coronavirus-related hardship. As opposed to proactive relief, the more recent directives are designed to help homeowners suffering foreclosures already in progress.
March 23: FHFA took action to help the commercial real estate sector. FHFA began offering mortgage forbearance to some multi-family borrowers if the landlords agree to suspend evictions of tenants unable to pay the rent. This initiative makes great sense by addressing the chain reaction problem. However, on its face, it seems to give too much discretion to the individual lenders on a case-by-case basis. The forbearance plan requires the borrower/landlord to show “hardship as a consequence of the virus” to obtain lender approval.
According to FHFA, only about 43% of the multi-family market is eligible for relief, and landlords must not evict tenants solely for non-payment of rent. Cynics may wonder if some landlords would find a non-monetary pretext to evict non-paying tenants, so they could receive mortgage payment relief while seeking a new tenant.
April 2: In Florida, Governor Ron DeSantis signed executive order 20-94, Emergency Management – COVID-19 – Mortgage Foreclosure and Eviction Relief. The order suspends and tolls all mortgage foreclosures and evictions in the state of Florida for the next 45 days due to the COVID-19 pandemic. However, the action does not relieve individuals of their obligation to pay their mortgage or rent payments.
Despite well-intentioned government intervention efforts, our real estate market, like the global economy, is in for a world of pain. History tells us that government relief will likely be incomplete, ineffective and temporary. Absent a miraculously quick recovery, borrowers and tenants will stop paying lenders and landlords and there will be great collateral damage.
In the years following the 2008 recession, the U.S. government passed various initiatives to mitigate the foreclosure crisis. They included, among others, the Home Affordable Modification Program (HAMP) to help borrowers cure their mortgage defaults and the Mortgage Debt Relief Act to temporarily stop forgiven mortgage debt from being taxed as income.
Overall, these initiatives failed to deliver significant large-scale relief. Taxpayer-funded bailouts helped the financial and banking industries who caused the crisis but didn’t do enough to rescue borrowers.
HAMP failed mainly for giving the lenders too much discretion and insufficient direction to help distressed borrowers. The banks lacked motivation to provide the relief needed to keep most borrowers in their homes. The lending industry was also woefully unprepared to respond to the massive mortgage crisis and process the flood of relief applications. This ineptitude applied to loan modification applications as well as short sales. There is little reason to believe these conditions will change much this time around.
If legislation and government initiatives won’t defuse the crisis, then much of the nation is heading to court.
During the Great Recession, the free market economy ran its course and thinned the herd like a nature show. Across the country and mainly in hot spots like Florida, foreclosure filings and evictions overwhelmed the judiciary. Because it’s usually better to avoid battles than to win them, the key for all real estate stakeholders is to be proactive and seek fair solutions to preempt lawsuits and contain the damage for everyone.
You Have to Talk
A sensible first step for a distressed borrower is to contact their lender or loan servicer to discuss a workout plan. A forbearance plan, as discussed above, would allow the borrower to defer payments for some time until they can resume consistent payments. Much has already been written about how the usual forbearance arrangement may set up borrowers to fail. Typically, forbearance only kicks the can down the road to make up missed payments later. Most borrowers won’t have money for the back payments while they’re still struggling to make the current payments.
A loan modification involves a more intensive re-working of the mortgage agreement. Part of the principal balance may be forgiven. The interest rate may be reduced. A portion of the outstanding principal can be chopped off the top to calculate interest on a lower principal with the deferred portion paid off at the end of the loan or upon sale of the property. All of these arrangements can work with residential or commercial mortgages.
I represent private, “hard money” lenders and investor clients who buy mortgage notes on a secondary market. These lenders, along with the big institutional players, need to talk with their borrowers about workout plans at the first sign of distress.
Whether you’re a lender or borrower, consider the following solutions. In practice, it’s usually easier to make deals with the smaller, more flexible lenders, as was the case during the last foreclosure crisis.
Investor Role
Some investors seek to buy “non-performing notes” with borrowers in default. All investors with cash reserves should consider such buying opportunities now. These bargain investments create great, win-win recovery opportunities. Investors buy mortgage debt based on a percentage of the fair market value of the property securing the debt. Delinquent notes, it stands to reason, sell for a lower percentage of the property value than performing debt.
When the investor buys discounted “paper” from the originating lender, there’s a buffer between that purchase price and the property value. This gives the parties wiggle room to modify the terms so that the borrower may resume payments. The loan modification methods discussed above can work well for investors and their borrowers.
Lender History Lesson
A common refrain from my borrower clients during the foreclosure crisis was that the lender wouldn’t work with them while they remained current on their payments, even as the borrowers were at the brink of default. From the lender’s perspective, if they’re getting paid, there’s no problem – and no incentive to modify. This ignorant, wishful thinking aggravated and prolonged the crisis.
Lenders pushed struggling borrowers paying in good faith to default. This forced lenders to be reactive and attempt to solve, rather than avoid, problems and incur far greater costs from going to court. They also flooded the market with bank-owned properties that further reduced values in a destructive vicious cycle.
Exit Strategies
Some borrowers will prefer an exit strategy to relieve them of the debt and leave the property. That can also be negotiated. If the property is “upside down” for being worth less than the outstanding mortgage balance, a common solution is a short sale.
During the foreclosure crisis, many homes were short-sold. A short sale requires the lender’s approval (along with other potential lien holders, such as second mortgage lenders and the HOA) and willingness to accept a reduced payoff to close the deal.
Sometimes, the lender will authorize some relocation money to trickle down to the borrower, but in general, all sale proceeds, minus closing costs, go to the lender. The most important condition for the borrower to negotiate is a deficiency waiver. This means the borrower is relieved of liability for the difference between what they owed the lender and what the lender collected. Be aware that the lender will always file a 1099-C debt cancellation form with the IRS, which makes the forgiven debt taxable to the borrower as ordinary income.
Currently, there’s still much equity, so many property owners can sell at a price sufficient to pay off the lender and pocket some proceeds. Depending on how quickly and severely the market falls, that equity may evaporate and put many upside-down properties on the market again soon.
Distressed tenants should also be proactive in attempting to resolve problems before an eviction action is filed. Because Florida eviction laws are much more favorable to landlords than foreclosure laws are to lenders, lease workouts are more challenging.
Importance of Facing Reality
In many cases, especially with commercial leases, negotiating an early termination or lease buyout may be the best course. Again, sooner is better, for both sides to make arrangements to move on. Business owners will have to accept economic realities, including the need to downsize to survive and rebuild.
“Everybody has a game plan until they get punched in the nose.” Mike Tyson, former heavyweight boxing champion
Being proactive in seeking a resolution – before the situation deteriorates – remains the best economic and legal plan. However, sometimes a resolution can’t be found, and someone chooses the nuclear option of litigation. For this, you should prepare for fight or flight.
There will likely be many foreclosures and evictions filed in the coming months or years. As a lender or landlord, you may have to file a foreclosure or eviction. As a borrower or tenant, you may defend such cases. To prepare, there are some important things to know.
Litigation – It’s Going to Cost You
The first important thing to know is that litigation is, as my Boston friends would say, wicked expensive. To pursue or defend a lawsuit, you’ll very likely need to hire an attorney and pay their fees and their paralegal’s fees by the hour. If the party in a lawsuit is a corporate entity, Florida law requires them to retain an attorney. They cannot represent themselves. Any lawsuit can quickly lead to thousands of dollars of legal fees and court costs.
Consider your leverage relative to the opposing party. Our justice system is flawed in many ways. One of them is that the side with the most money to burn (bigger weapons) usually has an advantage, regardless of the facts or merits of the case. Litigation is like the Cold War arms race where the U.S. pushed the Soviets to the brink of economic ruin, and we know who won that fight.
Foreclosures and the Courts
This economic reality is typically not as harsh for foreclosure defense clients going up against institutional lenders and their “foreclosure mill” law firms. Following the market collapse of 2008, I represented hundreds of real estate investors and homeowners defending foreclosures. For a variety of reasons, we were able to fight effectively and contain the damage, despite the economic disparity.
The court system was completely overwhelmed and unprepared to process for the volume of foreclosures filed. This caused great delay and institutional chaos that allowed borrowers to stay in the fight longer. Many lenders had flawed, defective and fraudulent cases giving rise to legitimate legal defenses. The lenders’ attorneys were often overworked and disorganized. These circumstances helped even the playing field, but borrowers can’t rely on such conditions to repeat.
Landlords vs. Tenants
Evictions in Florida are weighed much more heavily in the landlord’s favor. Both residential and commercial evictions are filed under a summary procedure statute. This means that instead of having twenty days to file a response to the lawsuit, like most cases, including foreclosures, the tenant must file an answer in five days.
There’s also a “pay to play” legal provision that favors landlords and hurts tenants. This means that, unless the tenant’s defense to the case is that they paid, which is rare, they have to pay the rent as it comes due into a court escrow account while defending the case.
The tenant may raise defenses and legal arguments and even file counterclaims, but they have to keep paying all the while to avoid eviction. At the end of the case, the judge determines who gets the money from the court registry account. These legal and economic realities should motivate tenants to resolve their disputes before being sued.
When It’s Not Too Late to Settle
It’s also important to know that all of the pre-litigation settlement options discussed above remain available after a case goes to court. In fact, it often takes the costs, delays and uncertainty of litigation to inspire the parties to settle. Often, the longer and more expensive the battle becomes, the greater the motivation to resolve the case, cut losses and move on.
I’ve represented hundreds of clients in real estate legal matters, including private lenders and note buyers, investors, families, landlords and tenants. It appears that we’re entering the next recession leading to lots of money being lost and lawsuits filed. As part of my commitment to helping clients stay informed, I will continue to provide updates about the real estate market and related impacts and issues.
Most importantly, all real estate stakeholders should be proactive in seeking litigation-avoidance solutions but be prepared to fight. Let’s learn from history’s lessons and not repeat the mistakes of the past.
At Widerman Malek, we’re ready to help our clients survive the storm. Currently, we’re helping small business clients obtain available government business relief funds. We also have the talent and resources of a dedicated team of professionals solving our clients’ problems in real estate, corporate, litigation, intellectual property, and government contracts, among other services. Contact me to discuss how our firm can serve you. Stay safe.
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