As California businesses and authorities look to reopen the economy, the ongoing restrictions on evictions and other enforcement actions by landlords are leaving unresolved issues for landlords and their lenders.
After California Governor Gavin Newsom implemented a statewide eviction moratorium for tenants affected by COVID-19 on March 27, 2020, the California Judicial Council went further with its April 6, 2020 order. As we previously noted, the Judicial Council’s order suspends the issuance of summons and the entry of default and default judgments on unlawful detainer actions until further notice. And whereas Governor Newsom’s order applied only to tenants in “a residence or dwelling unit” who were affected by COVID-19, the Judicial Council’s order is applicable to any unlawful detainer action with only an exception for actions “needed to protect public health and safety”.
Some local governments have gone even further. Per the California Apartment Association, there are currently 38 municipal governments across Los Angeles, Orange, Riverside, and San Bernardino counties that have implemented their own separate tenant protection initiatives—with some of them being more stringent than the statewide executive order by including clauses that prohibit late penalties for not paying rent or providing tenants six months to pay back rent charges (a list of state and local restrictions nationwide can be found here).
The reality of the situation is that many tenants have lost months of income they will never recover. For renters who were already living paycheck to paycheck, that means they have no way to pay rent, and likely no way to catch up on rent even if they can regain their previous income level in the next month or two. Further, the blanket nature of the Judicial Council’s order has raised fears that even tenants who are still able to make payments may withhold rent. Tom Bannon, chief executive officer of the California Apartment Association, noted after the Council’s order that “the Judicial Council’s vote Monday invites tenants to withhold their rent even if they have the ability to pay it, leaving landlords struggling to pay their own bills and keep their independent vendors or employees working”. And in a state where the expense of housing was already a hot button issue, the additional weight of the pandemic has raised the specter of rent strikes.
While tenants and landlords are the parties most immediately affected by such measures, the current situation leaves serious issues unresolved for lenders as well. This article will discuss major issues that the moratorium orders have left unaddressed and provide advice for lenders on how to proactively manage their portfolio in the current environment.
How Will It End?
While the state government orders have made it virtually impossible for tenants to be evicted and some local orders have provided additional time to make back payments, none of the orders have provided rent forgiveness. If the orders are lifted without any further action, then any tenants who have fallen behind on their rent during the moratorium would need to either make back payments of all past due rent or face eviction. Indeed, two California state legislators and a group of legal aid representatives expressed concern via an April 1 online news conference that there will be a spike in evictions this summer as tenants will not be able to pay their accumulated debt from the preceding months.
The eviction moratorium is therefore only postponing the reckoning that will come from the widespread unemployment and underemployment resulting from the pandemic. Absent some type of government bailout, landlords will be faced with a situation where they need to either forgive some or all past due rent payments or conduct widespread evictions (and still take a loss on the past due rent). The mass incidence of unpaid rent has major implications for any lenders whose borrowers make monthly loan payments from the rental income of secured properties.
The Importance of Mitigation
Given the uncertainty over both rental income and the ability of landlords to enforce their rights, it is essential for lenders to be extremely proactive with their loan portfolio. Whereas many lenders would have previously negotiated a work-out with their borrower only after a default and perhaps some additional time to cure, in the current environment it is advisable for lenders to reach out to their borrowers even on loans that are still performing.
The economic effects of the pandemic will be felt on rental properties for many months to come, and while some borrowers may have enough reserves to keep making payments through a few months of hardship, the effects of the pandemic may be felt long enough for even relatively well-prepared landlords to eventually need forbearance. This will be true particularly if the eviction moratoriums stay in place longer than stay-at-home orders, as landlords will be unable to replace non-paying tenants with tenants who can pay.
By reaching out to their borrowers ahead of time, lenders can get a better idea of what income they can expect from their loan portfolio in the coming months and can get a head start on dealing with potential problem loans. Lenders may be able to work with their borrowers to reach modification or forbearance agreements that will provide both parties peace of mind and a sustainable path forward.
In the event that other mitigation efforts cannot provide a satisfactory solution, it is important to note that non-judicial foreclosure actions remain unaffected by any California state order at this time.