Call it uncertain or unprecedented, 2020 was an unusually challenging year for commercial real estate lenders. The COVID-19 pandemic was akin to a 100-year flood or hurricane that nobody could predict, rather than a normal economic downturn. In March of last year, many direct lenders pulled back from the market and others stopped lending altogether, practically overnight. In an uncertain economy and business environment, loan-to-value (LTV) ratios were immediately lowered.
With competitors leaving the field, many private lenders stayed active and took advantage of the market opportunities that remained. While traditional banks dramatically changed their underwriting guidelines and waited for the smoke to clear, the more aggressive direct lenders stayed the course —maintaining their customary interest rates and LTV standards.
This market, however, has been far from normal. Appraisals were one complicating factor during the peak months of the pandemic. Appraisers did not want to enter buildings and property sellers did not want appraisers in their buildings. As a result, appraisals were significantly delayed, although they became more normalized by third-quarter 2020. In addition, the normal appraisal methodologies that rely on rental income, occupancy rates and comparable sales have been less reliable. The pandemic has made it difficult to assess the true value of many assets.
Starting this past summer and into the fall, the market has been in recovery mode. Even with an essentially V-shaped recovery, however, challenges remain. Certain areas of the economy have nearly returned to normal while others remain in the doldrums.
Good news came this past December through an extension of unemployment benefits, stimulus checks, Paycheck Protection Program (PPP) lending and other assistance via federal legislation. Still, commercial mortgage brokers should be aware of how private lenders now view the major real estate market segments.
With competitors leaving the field, many private lenders stayed active and took advantage of the market opportunities that remained.
Uneven performance
The outbreak of COVID-19 affected the various asset classes to different degrees. The hospitality industry was obviously one of the hardest-hit markets as shelter-in-place restrictions and social-distancing measures resulted in widespread conference cancellations and leisure travelers staying home. Direct lenders have been able to serve as a lifeline to many hotel owners as PPP loans and other financing options dried up.
COVID-19 also accelerated trends for office properties, such as greater work-from-home flexibility. As with hotels, traditional lenders have been wary of the office sector, given the challenges for predicting the solvency of tenants. Many direct lenders remain skeptical about this space, too, but the more aggressive private lenders see opportunities as the business climate returns to balance.
The apartment sector has not been immune either. Lower-income workers were hit hard by the massive wave of unemployment throughout the spring and summer of 2020. There’s no way to sugarcoat the issue: Tenants have taken advantage of rent forbearances that prevent evictions, making this a tricky market for landlords who still need to pay the bills.
Within the multifamily universe, manufactured-housing communities (MHCs) have performed solidly throughout the pandemic, but they could face some difficult months ahead. For property owners in normal times, MHCs are generally a cash cow. As with apartments, however, tenants have had the upper hand on landlords since the early days of the economic slowdown.
Meanwhile, the residential fix-and-flip and fix-to-rent markets remained busy. This is always a competitive market among direct lenders. The continuing strength of the single-family residential and multifamily sectors has made it even more intense.
In many U.S. markets, there is more money available for deployment than planned deals.
Road forward
Direct lenders have become more conservative in underwriting loans. Although direct lenders tend to be solely interested in the value of a given property, the coronavirus-era business climate has forced them to take a closer look at the future income prospects of a borrower.
Making a loan on an apartment building, for example, requires additional caution given the current federal and state protections for consumers and renters. A private lender will look at the track record of rental rates and take into account the possibility of lower rents going forward. Similar principles would apply to a hotel in light of its occupancy level, location and seasonality.
Where a property is located has an impact on the willingness of a direct lender to provide financing. For example, Midwest states generally have implemented rules that are more favorable to renters and tenants than landlords, making evictions difficult if not impossible. As the economy starts to recover, some states are slowly starting to lift restrictions and allow evictions to go through — although others continue to push them back 30 days at a time.
Once the relief ends and restrictions are lifted, commercial real estate foreclosures will begin to rise. At the end of this past August, aggregated commercial mortgage delinquency rates were relatively unchanged despite the serious stress felt in the retail and hotel sectors, according to the Mortgage Bankers Association (MBA). Nearly one-quarter of all hotel loans and 15% of all retail-property loans were delinquent at that time, MBA reported.
Delinquencies remained low in the multifamily, industrial and office sectors. Inevitably, we will see a wave of foreclosures in these markets at some point in the coming months — although it should be noted that direct lenders and investors prefer receiving their monthly payments rather than having to foreclose.
Strangely enough, commercial real estate values have remained relatively stable — and in some cases, such as industrial properties, have continued to rise. This is a stark departure from the Great Recession when there was a flood of desperate sellers. Fire sales are not occurring in the present market. Investors are waiting for prices to drop while property owners are staying firm.
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As the restrictions on foreclosures and forbearances start to lift, we could see investors jump in and try to scoop up bargains. Early this past December, the market was still in something of a holding pattern. In many U.S. markets, there is more money available for deployment than planned deals. For mortgage brokers who are willing to keep working hard and knocking on doors, this means there are likely opportunities ahead — and private lenders are the most likely of the sources that can help get deals done. ●
