March 13th, 2020 10:56am
CLARITY AND CONFIDENCE FOR COMMERCIAL REAL ESTATE INVESTORS
If you ask anyone right now, what is going on, their general response is “we are still trying to figure it out”. This is a time where things are shaky and there is a sense of uneasiness floating in the air, given the Coronavirus. My hope, in this article, is to offer some clarity on what is going on the in commercial real estate markets and provide some practical wisdom on how you should move forward. The article will highlight every segment of the market, from a lending perspective. So here we go.
CMBS (Commercial Mortgage Backed Securities) Markets
This is an area of lending for investment property loans from 2 to 100 million in size. The format here is book the loan and then bundle them up to sell off as a securitization. What makes this most challenging right now, is how tied they are to the stock market; which seems to be in disarray. Every group is more than likely going to widen spreads (raise rates) and probably lower the loan to value. Furthermore, you are going to see a consistent move away from the hospitality sector. Along with this you will see closings taking longer, as due diligence travel is going to slow down. Chances are the markets are going to force lenders to re-trade the original terms. There is a high likelihood, at this point, that the majority of lenders tied to securitization are going to stop lending for now. Expect to see groups stop issuing commitments at this point.
Life Insurance Company Markets
Life Companies are generally balance sheet lenders and focus on traditional office, retail, industrial, apartment loans. They typically stay true blue during good, and bad, markets. The reason for this is that they are always fairly conservative on their underwriting. Right now, the general consensus is “business as usual”. They are closing loans and don’t see that stopping at all. The only thing that will probably change for them is pricing, as the 10 year is on an emotional rollercoaster. Response times will probably be slow, because people will be working out of their home. Corporate bond spreads have widened and henceforth the rates are going higher...this is an opportunity cost issue. All of them are going to tighten their underwriting.
Banks generally focus on relationship opportunities and are looking for long term clients. Their focus is to gain business deposits and work towards local community relationships. Right now everyone seems to be optimistic that this is “a blip on the screen” and should settle down in a few months. They are keeping their eyes peeled for clients in vulnerable industries to see how they can help. The only thing you might see change is how they price things right now. Other than that, they are ready to lend money.
Small Business lenders are focused on doing 7a and 504 loans. They work with small businesses that are trying to expand their business by buying, refinancing or building operational facilities. Right now, the only SBA government feedback is a “disaster relief fund” set up for people that fall victim to the Corona Virus. For more information on that program please visit SBA Disaster Assistance. Also the SBA application is here Most of the lenders have expressed their continued interest to proceed with lending; business as usual. They are, however, probably shying away from the hospitality market, and restaurant arena. Expect to see major assistance from the Federal Government, which might include waiving of SBA fees, higher guarantees for lenders, increasing the SBA express program to higher loans and other changes. The hope is that this will incentivize lenders, and borrowers, to proceed forward with borrowing money.
Bridge Lending Markets
Bridge lenders focus on lending against income properties that are in a turn around situation. They lend to people who are going to renovate and lease up the properties, with the intent they will be taken out in 24 to 36 months. All of the bridge lenders, that are balance sheet, are fine. This means if they are not CLO (Collateralized Loan Obligation) lenders they are proceeding forward. The CLO lenders are probably going to play things a little closer to the vest, as the markets are a little shaky; they can’t sell bonds right now. Furthermore, you will see lenders putting a floor on their internal interest rates right now…money is getting too cheap.
Agency Financing Markets (Fannie/Freddie)
Agency lenders loan predominately against multifamily properties that are needing permanent lending. This can include fixed rates for 5, 7 and 10 years on a 30 year amortization. Most of the agency lenders, which have been around for a while, are proceeding with their loans. Where things are probably going to change is in their interest rate pricing and timing of close. The markets have been so volatile, and rates have gone down too much. Most groups have actually come back and re-traded their loans that are in process. If you were are 3.75%, then you might be bumped 25 to 50 basis points. The reason for this is that it is too low for them to make money. Furthermore, be prepared that things will take longer because third party vendors refuse to do their jobs, i.e. go into properties, etc. Here are some new guidelines for investors to be aware of for now: - Interior unit inspections are not required however FM still wants to be able to confirm that units are occupied by having the tenant open the door and take photos of the interior from the hallway - Speak with tenant (through the door is okay) and verify name, rent paid, how long they have lived there and the condition of their unit - FM also offers additional practices to confirm occupancy such as observing electric meters, utility bills, packages to confirm tenancy, etc. - There will likely be additional due diligence requirements added to the INL such as bank statements, more leases for lease audit, general ledgers, etc.The circumstances surrounding the COVID-19 pandemic have caused unprecedented disruption in fulfilling certain underwriting and purchase requirements, such as site inspections and third-party reports. To continue to provide liquidity for borrowers, the Freddie Mac Small Balance Loan (SBL) team will temporarily require a 12-month Debt Service Reserve (DSR) for all new and uncommitted SBL loans during this time, effective March 30. All commitments will require inclusion of the COVID-19 Debt Service Reserve Rider, which will be posted shortly on our website with our other loan documents. Until it is posted, the rider will be attached to issued commitments. With this DSR in place, Freddie Mac SBL may allow loans to proceed amid the potential economic impacts of COVID-19 and be purchased with certain modified due diligence reports, such as appraisal, zoning, inspection, physical risk report and seismic. Accessing Funds to Pay the Mortgage: The borrower will need to submit a request with supporting documents showing less than breakeven collections to be able to apply funds from the DSR to the payment of principal and interest. Releasing Funds Back to Borrower: The release of the remaining DSR will be within 30 days following satisfaction of the following five items: 1. Lender receives a release request from the borrower. 2. All federal, state and local emergency declarations or similar government actions related to COVID-19 have been lifted for at least 90 days. 3. All due diligence items have been completed to Freddie Mac’s specifications and borrower has remediated all deferred due diligence shortfalls. 4. If borrower and Freddie Mac entered into a forbearance agreement, all of the forborne debt service payments have been repaid. 5. Borrower provides evidence satisfactory to Freddie Mac of residential occupancy at a minimum of 80% and collections, on a three-month average and for the last month, that satisfy the policy minimum underwritten Debt Coverage Ratio (DCR) for the loan. For example, 1.20x for Top Markets, 1.25x for Standard, etc., with appropriate adjustments for cash-out, full-term interest-only, etc. Here are a few additional details to note: · If the borrower does not satisfy the five items above within 12 months after the Effective Date of the Loan Agreement, the remainder of the DSR will be used first to pay down any remaining forborne debt service and then transferred to the Capital Replacement and Repair Reserve for the balance of the loan term and may be used to reimburse the borrower for the cost of Capital Replacements. · Borrowers may choose to participate in forbearance per the terms of the CARES Act and Freddie Mac’s guidelines. If the borrower chooses forbearance, the forborne payments will be spread over the following 12 months’ debt service payments. If borrower’s repayment of forborne amounts begins while the DSR is still in effect, for any month where collections are below breakeven, borrower may also apply the DSR to that month’s 1/12 repayment of the forborne amount. · For properties located in areas where Freddie Mac requires a seismic report, SBL will require the borrower to carry earthquake insurance on the property until a satisfactory seismic report is complete. · The lender must provide evidence that the recordation office has received the request to record in order for Freddie Mac to purchase the SBL loan.
NNN Lending (Single Tenant Financing)
These are balance sheet lenders who focus on providing long term permanent financing for single tenant properties. This includes tenants like Dollar General, Family Dollar, Fresenius, CVS, Walgreens, etc. Typically they are funding loans from 750,000 to 10 million and higher. They will offer 5, 7 and 10 year fixed rates with a 25 to 30 year amortization. At present, these balance sheet lenders are business as usual, but will probably not go much lower on their rates, which are hoving in the high 3's and low 4's. My sense is that you will see a little tightening on the underwriting, but their will be a huge flight to quality tenants right now. This will probably mean borrowers will need to put down more money, i.e. 35 to 40% as demand will be up.
Again, we know this can be an anxious time, but our sense is you don’t need to be. The best road ahead is to a) gain wisdom, b) plan and c) take action. For further questions please contact David Kotter at email@example.com or 480-219-1205.
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