What Real Estate Borrowers Should Know About PPP and Debt Restructuring

Many real estate companies applied for and received the Small Business Association’s (“SBA’s”) Paycheck Protection Program (“PPP”) loans. These funds have helped bridge cash flow shortfalls due to deferrals or non-payment of tenant rent. Soon, all PPP borrowers, including real estate companies, will have to turn their attention to preparing what might be a tedious and detailed process of applying for loan forgiveness. This is a critical and necessary step in converting from a loan to a 100% forgivable grant.

As real estate owners deal with many challenges, they must also focus on how to maximize PPP loan forgiveness and consider how the PPP loan may influence strategies for dealing with the property’s other debt—its primary mortgage loan and other financings.

Here are several considerations to help maximize PPP fund retention.

PPP Loan Forgiveness

Once PPP funds are received, you must thoroughly document expense disbursements. Payroll, rent and leases, mortgage interest and utilities are the “covered expenses,” with payroll having to account for at least 60% of funds usage. Accordingly, it is important to prepare a complete and thorough financial information package. The information is best submitted to the PPP lender in a single comprehensive package rather than piecemeal. There appears to be little incentive to submit early and perhaps take the chance of making an error or have new rulings issued that you might have to also account for. There is plenty of time to submit the package, approximately 10 months from the forgiveness period.

In most cases, payroll expense will be the largest component of the forgiveness application. Many payroll companies, like ADP and Paychex, have created reports specifically for PPP reporting. Take the time to make sure the reports cross reference to your local banks and the SBA reporting form.

The SBA periodically provides updated guidance through frequently asked questions (“FAQs”). Recently, there has been new guidance for reporting owner’s (greater than 5%) compensation, change of control, related-party rent expenses, and other areas. Before you make your final submission, review the FAQs and guidance so that your submission takes into account the entirety of the guidance. Also, consider having a third party review your application before submission. Most borrowers have received loans of six or seven figures; accordingly, regardless of “loan size” it may be worth having an independent party analyze the entire submission package. 

Debt Restructuring Considerations

Reduced rental revenue is making it difficult for many property owners to pay the full amount of debt service on time. With or without a PPP loan, borrowers and mortgage lenders have been executing forbearance agreements that provide for reduced or no mortgage payments for some period of time. If the pandemic continues and those arrangements expire without an improvement in cash flow, owners will be forced into additional debt restructuring discussions with their mortgage lenders.

Having a PPP loan may or may not influence borrower and lender discussions. Some, but not all, of the factors include size of the loan, whether the proceeds have all been used and/or if the real estate owner has other funds available to provide additional support for a loan restructure. It’s generally preferable to approach a lender after the PPP loan has been resolved—either repaid, forgiven or a combination of the two. While the PPP loan is unsecured and, therefore, subordinate to the mortgage lien, a lender will typically consider all of the borrower’s indebtedness, PPP repayment requirements and timing in reviewing a modification request. Ideally, the PPP loan should be forgiven prior to the start of restructure discussions. In the current chaotic environment, however, the borrower may be facing a potential default and cannot wait for the SBA to forgive the loan. The forgiveness application process could take up to five months, so waiting, although preferable, may not be an option.

As mentioned above, early in October the SBA released new guidance in the event there is a change in control in the entity that received a PPP loan. Accordingly, these rules will be relevant if the borrower is recapitalizing the ownership entity with third-party funds as part of its overall restructuring strategy. The guidance defines the various transactions that would be deemed a change in control. Any entity merger or infusion of capital would not relieve the borrower of its obligation to repay the PPP loan or follow any of the administrative requirements of that loan. Depending on the nature of the transaction that resulted in a change in control, the percentage of ownership transferred, and whether the PPP loan will be repaid as part of the transaction, various rules apply relating to notification to the PPP lender and lender approvals. Real estate owners should be aware of these rules before closing any transaction. Generally speaking, proactive/early understanding and planning is better.

If there is no white knight and the distress ultimately requires a bankruptcy filing by the real estate owner, in the normal course and most instances, the PPP loan is unsecured and the PPP lender would become an unsecured creditor of the estate. If the mortgage lender forecloses on the property, the PPP loan would remain an indebtedness of the borrowing entity.

The PPP loan program has been a vital lifeline to businesses across all industries in a volatile economy. Real estate owners who took advantage of these loans must be aware of the evolving set of administrative and compliance rules around reporting and the forgiveness application to maximize forgiveness. As owners approach their lenders to discuss long-term mortgage loan restructures, bear in mind how the lender may view the PPP indebtedness and how those loans should be dealt with as part of the overall restructuring or recapitalization strategy of the borrowing entity.