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14 Apr 2020

Lenders should be encouraged to show flexibility on real estate loan covenant breaches

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Both regulated banks and unregulated lenders should be encouraged not to impose financial penalties on property investors for breaching lending covenants on commercial property loans says Boodle Hatfield, the leading private wealth law firm.

A rent “strike” by some tenants, such as retailers, means that many landlords are in technical breach of the conditions (covenants) of the loans that they have agreed with lenders.

Lenders can often use a breach of a covenant to impose, what amounts to, a financial penalty on the borrower. For example, the landlord might have to pay a higher rate of interest, come up with money to pay down some of the loan at short notice, pay a one off fee to the lender or pay for a property valuer to do a new valuation of the property.

Boodle Hatfield says that as these breaches of covenants (caused by unpaid rent) are partly due to the Government promising to prevent landlords from evicting tenants their should be vocal support from the Government for landlords negotiating covenant breaches with their lenders.

The issue of how banks treated commercial property covenant breaches in the last recession was a huge area of controversy. Some landlords claimed that high street banks were far too aggressive in trying to turn covenant breaches into extra sources of profit for the banks.

Adam Chamberlain, Partner at Boodle Hatfield said: “There is a wide group of property lenders, including completely unregulated lenders, who may feel less pressure to be “fair” to landlords in the current crisis than the big high street banks.”

“We are sure that the big UK banks are going to take a more collaborative approach to covenant breaches than they did during the credit crunch but they only represent a proportion of the market and [a lot of commercial property lending is an unregulated activity].”

“The Government’s decisions to stop landlords evicting tenants has had the unintended consequence of putting many landlords in breach of their loans. That problem needs attention.”

Since the last recession a number of hedge funds, private equity funds and UHNWs have stepped in to lend to the commercial property markets.

Adam explains that the non-payment of rent by tenants may breach loan covenants that cover areas such as:

  • Void periods on rents
  • Rent arrears
  • Projections of rental income over the next 12 months that need to be a minimum percentage of the interest payments on the loans

Chamberlain added: “If you are a landlord, that fears you are going to breach covenants, the best thing to do is approach your lender early and negotiate a solution.”

“Lenders don’t want to seize properties from borrowers but they can still impose a lot of financial penalties that fall short of that. If you are a borrower you don’t want that to happen.”

This article first appeared in CoStar, Mortgage Introducer and Specialist Finance Introducer.