Financing Commercial Real Estate Stalls with Covid-19
By: Clifford A. Hockley, President Bluestone and Hockley Real Estate Services,
Executive Director, SVN | Bluestone and Hockley
On the 15th of March 2020, in response to expected economic implosion due to the corona virus, in an unusual move for a Sunday, the Federal Reserve reduced interest rates to almost zero. Banks and other financial institutions contemplated that for a week and then decided they would lower interest rates to borrowers to about 3%.
That reduction lasted about a week, before Governors across the country closed pubs, restaurants and all locations where people could congregate. Those businesses not only laid off staff, but also rushed the banks looking for capital to carry them through the crisis. Financial institutions realized almost immediately they had to reallocate their assets and basically closed out lending except for their very best customers. The Covid-19 Crisis was officially born.
New Environment- What can you expect?
There will be fewer property sales due to:
- Market place uncertainty
- Lack of property income (since many tenants cannot pay their rent) which makes properties hard to finance and underwrite and may depress property values
- Lack of available financing and higher interest rates making some deals unappealing to investors
- Probability that properties will underwrite to new standards
- Lack of resources to complete due diligence (due to “stay-at-home” orders, and Covid-19 risk) such as:
- Inspections of units will not be available for sales;
- Surveys, level one environmental, structural
- Fewer lenders because some have exited the marketplace
- Projects under construction- may have their loans cancelled or slowed down
- Appraisers will be unable to deliver appraisals that banks will accept due to marketplace uncertainty
Financing in the Northwest
Many refinancing commitments issued in March 2020 have been cancelled by financial institutions.
We have been told that the following banks are temporarily not extending new real estate loans: Boeing Credit Union (BECU), Chase, Opus Bank, UMPQUA, US Bank, or if they are lending its limited to their best clients, at interest rates from 3.5 to 4.5% with significant limitations in place. (This information is a moving target and changes every day).
Most institutions are currently underwriting their deals at interest rates that may force a lower loan amount. It is safer for them to lend less, 50% or 60% of the purchase price for example. Additionally, they may be asking for 3, 6, 9 or 12 months of reserves to cover the interest payments of the loans they are extending, using these funds to pay the mortgages for next 6 months or more. We have heard that even hard money lenders are also asking for 12 months of mortgage payment reserves.
Interest rates have increased significantly from the low rates in the middle of March 2020. This is discouraging those investors that flooded to the banks for refinancing after the Federal Reserve lowered its interest rates to near zero on the 15th of February. The Refinance market is stalled for right now. It makes no sense, unless you have a loan that is expiring. It might be better to negotiate an extension with your existing lender.
Banks are going to deal with the uncertainty of April and May’s rent collection, by lowering the amount they loan and increasing reserves.
The major reason lenders are nervous is because they are being overwhelmed by their existing business lending needs. Bank resources are being funneled to the clients that are recapitalizing themselves and are looking for a cash buffer against continued uncertainty.
Opportunities and Challenges
There will be opportunities for cash buyers. Some developers may fall out as their apartment buildings don’t fill up because their rents are too high. Retail buildings and Hotels are taking a real beating with high short-term vacancy rates.
Industrial: The unprecedented shut down of retail stores is creating an immediate greater need for warehouse space to accommodate online shopping and home delivery. In the long term, warehouse leasing is expected to slow as consumer spending is drastically reduced and businesses proceed more cautiously. (Source: CoStar News)
Logistics: These companies may repurpose warehouses used for discretionary goods to store food and household staples. Pharmaceutical, medical and food supply related tenants may shift to shorter leases to accommodate surge in demand.
Multifamily: In the short run, those that are experiencing financial stress, will move out of their apartments and go home to live with Mom and Dad. This may increase vacancy rates and lower rents. Most affected will be the Class A brand new properties. Financing institutions will be paying close attention to this and will be increasing their call for review of annual property financials. For April, property managers expect that in excess of 80% of the rents owed will be collected.
Office: With a sudden increase of teleworkers, employers may recognize the benefit of this potential cost savings, with office leasing expected to decline in the long-term. However, with most office leases in place having at least a two-year duration, this market segment may not reflect impact from COVID-19 in the short-term.
Retail: With grocery and pharmacy remaining essential, restaurants restricted to take out and delivery, and many other deemed non-essential, the impact on this sector will vary based on specific retail type. Many non-essential retailers have furloughed employees, and many small business owners’ question whether they’ll be able to survive the downturn.
Hotels: The hospitality market may be feeling the most immediate impact of COVID-19, with the Portland Business Journal stating that the industry stands to lose $3.5 billion in room revenue per week during the crisis. In a March 27th letter to federal regulators, the American Hotel & Lodging Association and Asian American Hotel Owners Association addressed a request for further aid beyond the $2 trillion coronavirus bailout package, warning that it will default on at least $86 billion in collateralized loans within the next several months.
Information Provided Courtesy of Lewis and Clark Bank
Banks we have talked to see risk in the following areas:
Lending is still active for limited deals in:
- Mobile home parks
- Industrial: Manufacturing and Distribution
Finally, on the first of April 2020, Fannie Mae has reissued financing guidelines, which we have included below. You can see that they are being very careful as well.
- All Tier 2 loans <$6M (1.25x/75): Require an 18-month principal and interest payment reserve, 12-month taxes and insurance escrow deposit, and 12 months replacement reserve deposit.
- All Tier 3 loans (1.35x / 65%): Require a 6-month principal and interest payment reserve, 6-month taxes and insurance escrow deposit, and 6 months replacement reserve deposit.
- If the loan is either full or partial I/O, the principal and interest reserve calculations will be based on 30-year amortization.
- Tier 4 loans (1.55x/55%) are the only exemption.
- Escrow amounts will be calculated upon rate lock. Tax, Insurance and Replacement Reserves will be determined by servicing as currently done on existing loans.
- In order to be given relief for monthly payments, the borrower will need to follow a process which includes a written request for relief explaining the circumstances causing the shortfall and plans to address them, providing certified operating statements for the prior month and bank statements for the prior 3 months. These requirements are outlined in the loan documents.
- The request will be made to your servicing representative assigned to the account.
- The Reserves shall be held for a minimum of 12 months and a maximum of 36 months. Prior to release, the loan must demonstrate it has met the minimum Tier Debt Service coverage test for 2 consecutive quarters.
Summary- Where is the silver lining?
In summary, the financial markets are still operating, albeit very carefully and slowly. They are waiting for the next shoe to drop, knowing full well that the policy makers will insist that they work out any problematic loans and work through a significant forbearance process.
Those at highest risk are the most highly leveraged, and that is where the opportunities lie for buyers. Given the federal financial injection and money that was already sitting on the side line waiting for a marketplace readjustment, there are quite a few buyers that have the ability to take on problems of the people who are in trouble and may be overleveraged.