The COVID-19 pandemic has radically changed the commercial real estate lending landscape as well as the outlook and predicted performance of these assets. Banks have pulled back and the lending market itself remains in flux.
Despite that, however, there are options for commercial mortgage brokers seeking financing during this challenging time. Private institutions that offer short- and medium-term bridge loans are expected to expand their reach as banks and other traditional lenders retreat.
At the beginning of 2020 and prior to the pandemic outbreak this past March, traditional lenders were already cautious and anticipating a slowdown. With the onset of the coronavirus crisis, the Federal Reserve took several emergency steps in March to shore up the economy, pushing the already low federal benchmark rate down to nearly 0%.
Although lower interest rates may appeal to consumers, banks were less inclined to approve applications at rates that low. The banks were tightening already-strict parameters on borrowers and the projects that they would fund. In addition to this rock-bottom interest rate environment, the shaky state of the economy after the pandemic hit in March immediately drove away institutional investors. Citing default risk, institutional investors largely stopped providing capital to smaller lenders.
This is not to say that it is all bad news for existing borrowers. Lenders learned lessons from the recession and financial fallout of 2008-2009. During that significant upheaval, many lenders were stuck with collateral they didn’t want and couldn’t unload. So, traditional lenders no longer want to foreclose on assets. They would rather work out a deal than acquire real estate. As a result, both banks and private lenders are likely to be more willing to modify existing loans during this rough period by extending maturity dates and lowering rates to avoid acquiring collateral. How this plays out will differ from bank to bank, as well as the terms of the actual deals involved.
It is clear, however, that banks and other traditional lenders are pulling back from new deals of all types. They are increasingly wary of all asset classes and all types of borrowers, including applicants with perfect credit. Borrowers with less-than-perfect credit or a blemish on their credit history, such as a bankruptcy, have a near-zero chance of getting approved. Likewise, raw-land deals and international opportunities are nearly impossible to fund via a traditional lender.
It would be impossible to address the current state of commercial mortgage lending without discussing the global COVID-19 pandemic. Credit was already tightening prior to the outbreak, but the economic havoc wreaked by the spreading disease has made the lending environment that much more difficult.
The financial fallout from this shock could potentially be felt for years to come. By mid-March of this year, commercial real estate owners were already asking their lenders for modifications, loan reductions and workouts. This was a result of not being able to collect revenue from restaurants, salons and other nonessential businesses that were ordered to be closed.
All of the major asset classes have been hurt but retail took one of the biggest blows. Forced closures of nonessential businesses and social-distancing recommendations from the Centers for Disease Control slowed consumer traffic to brick-and-mortar retailers to a trickle while sending more shoppers than ever to online retailers. Even before the pandemic, however, traditional lenders were wary of financing certain types of retail, given the rise of e-commerce and the closures of national retail chains and thousands of stores across the U.S.
Fueled by government-mandated closures of nonessential retail and a long-term trend of consumers electing to shop from home, the future of the retail sector is more bleak than other types of commercial real estate. Traditional lenders will therefore steer clear of this asset class. As for office space, technology has made it easier than ever for employees to work remotely. There’s an oversupply of space in many regions, including the Greater New York City area and some markets in Florida. Demand for office space also may take another hit even after the current crisis ends. Many businesses, now forced to work remotely due to the pandemic, will realize the cost savings that come with office-space flexibility. Traditional lenders are taking note and restricting who they lend to in this space.
Needless to say, as millions of people file for unemployment and restrictions on travel remain in effect, lending on hotels and tourism-related properties has come to a near halt. Domestic and international tourism will continue to take a hit throughout this year, even during peak travel periods. Even the multifamily-housing sector is not immune. Given the massive spike in unemployment, apartment rents will likely be severely impacted throughout the country, making traditional lenders leery of even this reliable asset type.
Traditional lenders are avoiding certain types of deals altogether. Land loans were always rarely funded by traditional lenders and they are out of the question now. A borrower would need to prove income from another source to be considered for a loan on a non-income-producing property. This leaves many borrowers with lucrative opportunities in the lurch.
Additionally, international deals will continue to go unfunded. Traditional lenders are already leery of applications to fund commercial real estate purchases outside the U.S. When traditional lenders tighten their parameters, international loans go from rare to nonexistent. Borrowers seeking an international loan from a traditional lender need not apply.
The pullback from the banks presents an opportunity for mortgage brokers to work with private lenders. First and foremost, a private lender doesn’t paint all loans of a certain category with the same brush, nor do private lenders tend to place a cap on the number of loans funded in a certain category at any given time.
Private lenders examine the merits of each deal, so every opportunity is evaluated based on its potential and the value of the real estate collateral, and not on an arbitrary cap or line. A few direct private lenders will even fund international deals in Mexico, the Caribbean and elsewhere around the globe, which many private lenders won’t do.
Direct private lenders can move faster than traditional lenders and other types of private lenders, since they lend directly to the borrower without relying on intermediaries such as investment banks. As a result, they typically do not ask for lengthy and intrusive financial documents, although you will need a clean title and environmental report, along with a current appraisal. Working with private lenders cuts down on the amount of paperwork the lender needs to make a decision, and that results in a faster closing than with a traditional lender.
Once the COVID-19 crisis passes, a deal’s timeline will become critically important. Bridge loans will become more urgently needed once construction and renovation projects pick up again. Projects that have been delayed or put aside will need fast and flexible financing options.
Designed to be secured quickly and paid back quickly, bridge loans close the gap between now and when a traditional loan application is expected to be approved. Traditional lenders take months to approve a loan, no matter how stellar the borrower’s history or how perfect the application. A bridge loan from a private lender fills the gap, so deals can get started without waiting for funding to come through.
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Even as the U.S. economy continues to fluctuate — and the COVID-19 pandemic continues to impact how we do business from day to day — a direct private lender can step in and ensure that borrowers have the funding they need to keep projects going, and that brokers are able to keep deals flowing. Although certain asset classes are hit particularly hard by these challenges, direct private lenders can continue to fund viable opportunities by securing funding quickly — often within days.