What Deals Can Be Made During Covid?
By Cliff Hockley, President of Bluestone and Hockley Real Estate Services
Executive Director, SVN | Bluestone and Hockley
We are all wondering if brokers and investors can find deals during the pandemic. The answer is a resounding yes!!! Investors, appraisers, and financial institutions are resetting their vision and policies to adjust to our new reality.
Consensus is this current environment is not going away anytime soon so we need to adjust. In addition, 1031 pressure has not abated, especially given the likelihood it might be done away with if Joe Biden gets elected. Many investors have stored up financial resources before the COVID – 19 downturn looking for a recession to profit from.
- Apartments – Especially those properties where tenants have consistently paid current rents over the last “COVID” months.
- Other apartment related considerations to consider:
- Very low-income market properties are finding high rates (30-40%) of delinquency.
- Middle-income units rented by predominantly white-collar tenants are seeing closer to 10% COVID-related delinquency rates. (Not as risky)
- Newly constructed high-end properties may have trouble getting financing, due to high vacancy rates.
- Mid-market properties appear to be attracting more attention than those in Global Gateway markets.
- Tertiary market apartment properties that benefit from local diverse economies (i.e., not in college or single-employer towns) are also desirable.
- Affordable housing – where the government pays the rent – also remains desirable in present market conditions.
- Other apartment related considerations to consider:
- Urban -infill properties that serve last-mile delivery applications
- Retail buildings where tenants have paid the rent
- Fully leased Medical Buildings
- NNN buildings where the tenants have paid rents
- Mobile Home Parks
- Owner user buildings using SBA loans – many businesses are choosing to take advantage of a buyer-friendly transaction environment coupled with a relatively borrower-friendly interest rate environment and fine print language in the CARES act, where the SBA will cover all loan payments and fees. This relief is available to new borrowers who take out loans within six months of the President signing the bill into law.
Appraisers are making adjustments
Appraisers are getting guidance from the Appraisal Institute. As a result, they are making significant edits to their appraisals. For example, appraisers are:
- Increasing CAP rate estimates (due to estimated lack of rental income or lack of buyer demand) which inevitably reduces property valuations
- Adjusting income estimates for properties and adjusting vacancy rates to allow for tenants that are not paying rent given COVID conditions.
- NOI adjustments (Both by estimating increased expenses and lowered income)
- Using verbal quotes from real estate brokers that reflect a slowed real estate marketplace
- This then gives shelter to appraisers to make additional “adjustments to lower the appraisal value”
- Often deleting the cost approach from appraisals as not being relevant for the time being. This limits value calculations to the income approach and the comparable approach
- Ignoring relevant near-term sale comps (with high CAP rates)
- Increase the weighting of appraisals to the low end of the income approach
To get deals done, investors and real estate brokers need to understand the current appraisal reality and adjust their deals to get them closed.
Financial institutions are making adjustments
Financial institutions are asking for the following deal alterations as part of their underwriting, to make loans:
- Higher down payments with loan to value adjustments
- Higher interest rates
- Larger prepayment penalties
- Lending is limited to investors with significant global net worth
- Lending to well-established investors with 10 + years of experience
- Asking Borrower for 40% or 50% down payments
- Lending only to those with existing relationships or those that are willing to bring a relationship to the bank
- Asking Borrower to leave 6 – 12 months of P and I loan payments in the bank as security that can then be applied to the first set of payments
Brokers and investors cannot wait for a recovery. They need to complete transactions now. There is an inherent demand in the marketplace driven by aging Baby Boomers who are trying to reposition their assets. This adds to the pressure of deals that were in the hopper when COVID arrived. “When we look back on COVID, what we will see is not a wholesale change in how we live and how we do business. Instead, we’ll see that already extant trends sped up,” explains Solomon Poretsky, Chief Development Officer of SVN International. He continues, “while we’ve seen some short-term change in the market in the long-term, the fundamental reasons that people do transactions will not change.”
The CARES Act and government support for business through SBA loans, PPP loans/grants, and extended unemployment benefits have been instrumental in supporting the economy. There is not an American who does not know that we all need to open businesses and get employees back to work.
The Fed has warned that the economy cannot fully recover until the labor market gains momentum. It may be likely that economic activity will not fully pick up until a vaccine is shared with all working Americans. “For the economy to fully recover, people will have to be fully confident, and that may have to await the arrival of a vaccine,” said Fed Chair Jerome H. Powell during a 60 Minutes Interview. He believes the economic recovery may extend through the end of 2021.
COVID-19 is creating a challenging environment to operate in. Buyers with cash or Sellers that can carry paper will be in high demand, to help brokers close deals. Sellers may need to make some limited concessions if they sell now, depending on the supply/demand characteristics of their marketplace. This being driven by marketplace valuation adjustments demanded by the financial industries.
Challenging environments are ones where competent real estate brokers truly prove their value. COVID has not changed the inventory – it is still there and, to a large extent, is still occupied and generating rent. Where the change has occurred is in how lenders, sellers, and buyers come together and craft terms that work for all of them. The assets are the same, but the market is different, and that change is affecting the deal risk and volume in the current marketplace. In the long run, most real estate investments will prove their worth.