The pandemic has changed the landscape of commercial real estate debt capital. Money is still available—but the rules have certainly changed.Some lenders have left the game altogether, while others are on pause. And those that are still active in the industry have become much more conservative, using different methods to reduce their risk and making their lending parameters much more stringent.In this blog, we talk about how commercial real estate lenders have started to adapt during COVID-19. This information may be helpful if you’re looking for CRE funding during these trying times.
Many commercial real estate lenders are staying away from certain property classes—particularly hotels and land—and construction projects. Even though many experts have predicted that the hospitality industry should recover in the next two years, lenders still have a low appetite for CRE assets in this sector.It’s still possible to find lenders who do business the land and construction lending, but those that were squirmy before the pandemic will also likely stay away from them right now.
It wasn’t unusual for lenders to lend anywhere from 75% to 80% of a commercial property’s total value before the pandemic. But this has changed. There has been a marked scaling back by 5% to 10% across the board—from construction to permanent financing to commercial bridge loans.Is it possible to still get 80% percent or even higher? Yes—but it will be much harder to find lenders willing to do this. Your best bet would be to consult a commercial real estate loan broker or commercial real estate capital advisor who can help you dig into underwriting with a long list of lenders to get higher leverage.
Lenders that provide permanent financing are typically adjusted 25 to 50 basis points higher relative to underlying bond indices such as LIBOR or US Treasuries Yields. While rates are lower on a macroeconomic scale, CRE lenders want to mitigate their risk and be compensated for agreeing to lend on that risk.Bridge in construction financing lenders is usually adjusted 50 to 100 basis points wider. So if your debt fund lender or bank was at LIBOR + 300 before the pandemic, they’re now likely to be around LIBOR + 350 to 400 for the same deal.
Lenders are now instituting a LIBOR floor rate of 1% for floating-rate debt. This is another new development because of COVID-19. What does this mean? Even if the one-month LIBOR index today is set at 0.20%, and your interest rate is LIBOR + 400, your interest rate will be 5% and not 4.2% due to the 1% floor.
Almost all lenders now require a reserve account with enough funds to pay the loan for at least six months (ideally 12 months). This was unheard of before COVID-19, but it’s easy to understand why lenders want this money set aside. After all, there’s always a risk that tenants might stop paying rent.
Nationwide lenders now prefer to be closer to home. Some of them only fund loans on commercial properties that are within 50 miles of their headquarters. Experts have also noted a decreasing lending footprint. Even big lenders that previously lent money for projects in the top 50 metropolitan statistical areas now tend to restrict lending only to the top 25 MSAs.
Lenders will hesitate if you don’t intend to reinvest your cash-out request into the commercial real estate asset to make it stronger. Some of them have even implemented no-cash-out policies. Those who still provide cash outs will need you to have a perfect reason to refuse to reinvest the money into the property. They will also want to know precisely what you will do with the funds.
Many lenders—especially credit unions and banks—are hesitant to lend to new relationships and no longer allow out-of-state sponsors. Borrowers ideally need to live in the state where the property is located.
Last year was undoubtedly a shocker for the commercial real estate industry, but many experts say that things should look better this year. With vaccinations starting to be massively rolled out, hopes are high that it will be easier to navigate 2021. Here are some of the trends and predictions for the CRE landscape:
COVID fatigue, mass vaccinations, and a receding pandemic should stabilize the CRE markets—and REITs are expected to benefit. Some experts predict that the FTSE-NAREIT All Equity Index will increase by 8% this year, with 4.5% from capital gains and 3.5% from dividends. Some sectors such as malls and hotels will continue to be distressed, but investors looking for investment opportunities may start putting money in these asset classes.
Even though lenders have been nervous, it’s important to note that there is money on the sidelines—over $200B in real estate equity. Optimistic investors expect this capital to be put to work this year in all property types. Many are also seeing discounted commercial real estate assets that may be ripe for investment. These include malls, urban apartments, office buildings, and even hotels.
Apartment rent control is predicted to continue to spread across the US. They already enacted in 2019 in New York, California, and Oregon. Many other states—particularly New Jersey, Minnesota, Illinois, Virginia, Maryland, and Massachusetts—are expected to follow suit.There is concern about bifurcation in the apartment market across the US: On one side will be A-tier red states with no rent control, and on the other will be B-tier blue states with disastrous rent control policies.Cap rates are expected to rise by 1% to 1.5% in B-tier states because of the adverse effects of anti-real estate rent control laws.
The outmigration of businesses and residents from urban blue cities such as New York, Chicago, Portland, Los Angeles, Minneapolis, Seattle, San Francisco, and others are likely to continue. This demographic shift is causing high vacancies in the office, apartment, and retail sectors. It is also driving the closure of many retail outlets while making condominiums and single-family homes less in demand.Commercial investment capital is predicted to decline significantly in such places. Investors may start refocusing on suburban locations around these cities and the red states.
Finally, CRE analysts think that private debt funds, private loan funds, and commercial hard money lenders will increase their market share this year. The CRE shadow lending market that provides mezzanine, bridge, high yield construction loans, and other short-term loans will increase its market share to 15% of total loans (from approximately 10%).
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