As the COVID-19 pandemic has created unprecedented challenges for the U.S. economy, federal and state governments have implemented a range of policies to protect people and help them meet their financial obligations. Many of these policies, such as the Coronavirus Aid, Relief, and Economic Security (CARES) Act, contain programs and terms that may sound foreign under normal circumstances.
In this article we will explain some of the top real estate-related terms you may hear as the financial uncertainty amid COVID-19 continues, and how they are applied in practice.
Bad debt – Bad debt is uncollectible debt. Due to COVID-19 and higher than normal unemployment rates, many lenders expect record-setting bad debt by the end of the year.
Collections Loss – Landlords experience collections loss when tenants are unable to pay their monthly rent. Lenders experience collections loss when they are unable to receive payments on delinquent loans. Typically, landlords and lenders assume a percentage of tenants will default on their obligations. While there was an expectation that landlords and mortgage lenders were likely to see higher collections loss due to historic unemployment because of the COVID-19 pandemic, through May, tenants have continued to pay rents at levels comparable to last year.
Commercial Mortgage-Backed Securities (CMBS) – CMBS is an asset-backed security similar to a bond where the underlying real estate assets are mortgage loans on commercial properties. CMBS allow banks to issue more loans by selling existing loans at a discount to investors. During the Great Recession, the residential mortgage-backed securities (RMBS) markets, similar to CMBS except that the underlying real estate assets are mortgage loans on residential properties, came under scrutiny due to banks’ liberal credit terms. It is generally believed these securities were one of the root causes of the financial crisis.
The current economic fallout is believed to be different, because the crisis was not caused by bad lending policies but by the spread of a virus, which no one could have predicted. The crisis could create new opportunities for lenders and investors as the economy begins to recover, especially in the multifamily sector as it has outperformed other parts of the real estate industry in past recessions.
Debt Service Coverage Ratio (DSCR) – In corporate finance, DSCR designates how much cash flow is available for current debt obligations in a one-year time period. Lenders use DSCR to determine a borrower’s ability to pay down a loan based on the property’s income and performance. In a healthy economy, lenders may approve more borrowers with a low DSCR. During a recession, however, lenders tend to tighten credit terms. For the next couple of years, banks and lenders may require higher DSCRs before issuing new loans.
Delinquency – Delinquency is when tenants fail to pay rent or borrowers fail to make a mortgage payment.
Eviction Moratorium – An eviction moratorium is a mandated halt to evictions. As previously mentioned above, if a borrower elects mortgage forbearance under the CARES Act, they must suspend evictions for those facing hardships due to COVID-19. Additionally, various states, such as New York and Pennsylvania, and some local municipalities, such as San Diego, have established a moratorium on tenant evictions during the COVID-19 crisis to protect affected tenants who cannot pay their rent.
Government-Sponsored Enterprise (GSE) – A GSE is a private agency that provides public financial services, such as the Federal Home Loan Mortgage Corporation (Freddie Mac), Federal National Mortgage Association (Fannie Mae), and Government National Mortgage Association (Ginnie Mae). These agencies are not lenders. They guarantee third-party loans or purchase loans on the secondary market. In a market beset with large collection losses and bad debt, they serve a useful purpose by adding liquidity that allows lenders to issue new loans.
Mortgage Forbearance – The CARES Act was signed into law on March 27. Among its provisions is mortgage forbearance for borrowers with a federally backed mortgage. It gives borrowers the right to request a temporary pause or reduction of mortgage payments for up to 180 days if they agree to suspend evicting delinquent tenants. Additionally, borrowers can ask for an extension of that forbearance for another 180 days. The forbearance is strictly for borrowers experiencing hardship due to the COVID-19 pandemic and not a blank check for all borrowers. Keep in mind, mortgage forbearance is not mortgage forgiveness. The missed payments must be repaid in the future. In addition to the federal government, local governments have also adopted mortgage forbearance guidelines to assist borrowers.
Paycheck Protection Program (PPP) – PPP is the Small Business Administration’s (SBA) loan program, which was established and funded by the CARES Act. Its purpose is to stabilize small businesses during the COVID-19 crisis so that employers can continue paying employees even if they aren’t working due to social distancing procedures, mandatory lockdowns, and nonessential business closures.
Special Servicing – A pool of performing CMBS loans are serviced by a master servicer that oversees the administration of the assets. If a loan becomes delinquent or otherwise non-performing, that loan will be transferred to special servicing where it is overseen by a special servicer. The special servicer is tasked with making certain the distressed loan is rectified, which can occur in several ways, including via a loan modification or even a sale of the loan from the pool. As a result of the financial fallout from COVID-19, there has been a spike in the loans transferred to special servicing, according to various news reports.