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August 23, 2024 — BY Hershy Donath, CPA

Commercial Real Estate Crisis Leaves Banks and Bonds Floundering

Commercial Real Estate Crisis Leaves Banks and Bonds Floundering
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The commercial real estate industry is heading towards a financing chokehold and that may translate into overwhelming stress for traditional sources of credit – namely banks and commercial mortgage-backed securities (CMBS). CREnews.com, in its “Year-End 2023: CRE at a Crossroads”, reports that about $2.8 trillion in commercial real estate (CRE) loans are maturing over the next five years, with $544.3 billion coming due this year, the majority of which are owned by banks and commercial mortgage-backed securities. Commercial real estate owners are experiencing a weakened demand for office space and a softening of property values. Previously low interest rates will be unobtainable, making refinancing untenable, and receiverships and defaults are looming. Lenders will look to unload defaulted properties at a much lower value. Lender’s CRE exposure, coupled with rising deposit costs, high levels of uninsured deposits, and declining asset values, have left commercial real estate owners – specifically, those holding maturing debt – in a very dangerous space.

Nomura analyst Greg Hertrich, quoted in a recent Reuters report, says, “Almost 50 U.S. lenders could fail in the coming years under pressure from higher interest rates and operational problems.” This projection is strongly supported by the FDIC’s published list of “problem banks” which listed fifty-two banks totaling $66.3 billion in assets experiencing financial, operational, or managerial weaknesses. In another analysis, conducted by Consulting firm Klaros Group, a review of 4,000 banks found that 282 banks face the threat of commercial real estate loans and potential losses tied to higher interest rates.

Earlier this year, the Federal Reserve published its Financial Stability Report, disclosing its assessment of the stability of the U.S. financial system as of Q1 2024. The study solicited views from a range of broker-dealers, investment funds, research and advisory firms, and academics concerned about the risks to U.S. financial stability. The study reported that banks with a significant exposure to commercial real estate loans could be headed for substantial losses if the trend towards remote work, high vacancy rates and slow rent growth continues. Funding tensions were also attributed to high levels of uninsured deposits and declines in the fair value of assets. The report’s respondents also noted that because interest rates may stay higher for longer than expected, there is a higher potential for “renewed deposit outflows,” or to use the colloquial term, “a run on the bank.”

Should borrowers worry? Some say not. In testimony in a May 15 Capitol Hill hearing on bank oversight, regulators opined that the banking industry is resilient, despite last years’ spate of bank failures. Martin J. Gruenberg, Chairman of the FDIC Board of Directors, testifying for the House Committee on Financial Services, said that banks have sufficient capital on hand, and sufficient liquidity to weather the storm. Gruenberg tempered his prognosis by noting that the banking industry continues to face significant downside risks from inflation, volatile interest rates, and global instability. The economic outlook is uncertain and “these risks could cause credit quality and profitability to weaken, loan growth to slow, provision expenses to rise, and liquidity to become more constrained.”

Lenders are walking a tightrope and that tightrope could easily be snapped by a change in interest rates, a global crisis, or borrower panic. In response, borrowers should stay aware, and start thinking about upcoming refinancing often and early. Traditional lending sources are sure to be compromised in the immediate future, and their available funds constrained and reserved for the best performing properties. By staying informed, property owners can strategically position themselves to address their refinancing needs.

 

This material has been prepared for informational purposes only, and is not intended to provide or be relied upon for legal or tax advice. If you have any specific legal or tax questions regarding this content or related issues, please consult with your professional legal or tax advisor.

August 01, 2024 — BY Yisroel Kilstein, CPA

Excess Benefit Transactions and How They Can Undermine Your Nonprofit

Excess Benefit Transactions and How They Can Undermine Your Nonprofit
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Most not-for-profit entities are familiar with the hazards of excess benefit transactions, but this brief refresher may enhance vigilance and compliance. The stakes are high. 501(c)(3) organizations determined by the IRS to have violated the rules governing excess benefit transactions can be liable for penalties of 25% to 200% of the value of the benefit in question. They may also risk a revocation of their tax-exempt status — endangering both their donor base and community support.

Private inurement

To understand excess benefit transactions, you also need to comprehend the concept of private inurement. Private inurement refers to the prohibited use of a nonprofit’s income or assets to benefit an individual that has a close connection to the organization, rather than serving the public interest. A private benefit is defined as any payment or transfer of assets made, directly or indirectly, by your nonprofit that is:

• Beyond reasonable compensation for the services provided or goods sold to your organization, or

• For services or products that don’t further your tax-exempt purpose.

If any of your organization’s net earnings privately benefit an individual, the IRS won’t view your nonprofit as operating primarily to further its tax-exempt purpose.

Private inurement rules extend the private benefit prohibition to “insiders” or “disqualified persons” — generally any officer, director, individual or organization (including major donors and donor advised funds) in a position to exert significant influence over your nonprofit’s activities and finances. The rules also cover their family members and organizations they control. A violation occurs when a transaction that ultimately benefits the insider is approved.

Examples of violations could include a nonprofit director receiving an excessive salary, significantly higher than what is typical for similar positions in the industry; a nonprofit purchasing supplies at an inflated cost from a company owned by a trustee, or leasing office space from a board member at an above-market rate.

Be reasonable

The rules don’t prohibit all payments, such as salaries and wages, to an insider. You simply need to make sure that any payment is reasonable relative to the services or goods provided. In other words, the payment must be made with your nonprofit’s tax-exempt purpose in mind.

It is wise for an organization to ensure that, if challenged, it can prove that its transactions were reasonable, and made for valid exempt purposes, by formally documenting all payments made to insiders. Also, ensure that board members understand their duty of care. This refers to a board member’s responsibility to act in good faith; in your organization’s best interest; and with such care that proper inquiry, skill and diligence has been exercised in the performance of duties. One best practice is to ask all board members to review and sign a conflict-of-interest policy.

Appearance matters

Some states prohibit nonprofits from making loans to insiders, such as officers and directors, while others allow it. In general, you’re safer to avoid such transactions, regardless of your state’s law, because they often trigger IRS scrutiny. Contact your accounting professional to learn more about the best ways to avoid excess benefit transactions, or even the appearance of them, within your organization.

 

This material has been prepared for informational purposes only, and is not intended to provide or be relied upon for legal or tax advice. If you have any specific legal or tax questions regarding this content or related issues, please consult with your professional legal or tax advisor.