Commercial Magazine

Prepare for A Year of Trouble

The pandemic could deal a greater blow to commercial real estate in 2021

By Farrukh Hasanov

As of late fall 2020, the nation’s fight against the coronavirus pandemic was far from over. The commercial real estate market remained perilously close to collapse.

The health crisis has created a different type of downturn. In other recessions, commercial real estate hasn’t felt the shock for roughly six months. But COVID-19 moved quickly across the country, immediately changing the fortunes of the market. And unlike other downturns, it is not clear when the virus will be under control and the economy can recover.

Market stress

According to real estate services company JLL, direct commercial real estate investment plummeted globally to $321 billion in the first six months of 2020, a 29% decrease compared to the same period a year earlier. Widespread lockdowns and travel restrictions forced companies to send their workers home while closing offices, restaurants, nonessential stores and hotels.

U.S. commercial and multifamily mortgage bankers were expected to close $395 billion of loans in 2020, a 34% decline from 2019’s record volume of $601 billion, the Mortgage Bankers Association (MBA) reported this past November. Multifamily lending alone was forecast to fall 21% to $288 billion, down from a record mark of $364 billion in 2019. MBA anticipated a slight increase in 2021 for commercial and multifamily lending, but analysts noted that the great uncertainty in the market made it difficult to project.

Stress is already being witnessed in loans underpinning commercial-mortgage backed securities (CMBS). As of September 2020, for example, Trepp reported that more than one- quarter of U.S. CMBS hotel loans and 18% of CMBS retail loans were in special servicing. In many cases, hotel and retail owners were handing back their notes, and assets had been auctioned for a fraction of their pre-pandemic appraised values.

The larger real estate market outside of CMBS has been somewhat insulated from the downturn by a combination of government relief to small businesses, foreclosure restrictions on landlords and the willingness of banks to work with borrowers. States and cities have imposed eviction moratoriums that prevent landlords from removing nonpaying tenants. Banks have not been foreclosing on many nonperforming notes. Once COVID-19 restrictions are lifted, however, there will likely be a wave of evictions and foreclosures. Experts anticipate this to occur in second-quarter 2021.

Day of reckoning

The Federal Reserve and Congress took unprecedented steps to shore up the economy and prevent small businesses from failing. JLL called the Fed’s posture a “whatever-it-takes approach” to monetary policy. Prior to the November 2020 election, Congress failed to pass another major stimulus and aid package that could have forestalled a new wave of business closures. Even if Congress passes new federal relief, however, there will eventually come a day of reckoning for tenants, landlords and lenders.

Once the restrictions end, commercial tenants will likely be given 90-day deadlines to repay months of back rent. In many cases, cash-strapped businesses won’t be able to pay and will be evicted. Landlords may have trouble finding new tenants in this economy, and will see higher vacancies and lower cash flows. In many cases, a landlord also will be behind on their mortgage payments. Lenders could be forced into a choice of forgiving portions of loans, or taking back the notes and selling the assets at steep losses, similar to what has already happened in the CMBS world.

All of this has had implications on the financing of new bank loans. During the crisis, the primary focus of banks has been on servicing their current loans and less on originating new loans. One of the core challenges that all lenders face is the unparalleled scale and distinctiveness of this crisis. The virus outbreak has affected every market in the U.S. and every asset type to some degree. The norms of evaluating the riskiness of an asset — such as the expected value and income of the property, or the borrower’s track record — don’t necessarily work anymore.

There has been ample reporting to suggest that banks are worried about their existing book of commercial mortgages. According to the Promontory Interfinancial Network’s second-quarter 2020 bank executive business outlook survey, bankers indicated that they were most concerned about the impact of the pandemic on commercial real estate and business lending.

Nearly half of the 557 bank executives surveyed cited commercial real estate lending as the most susceptible portion of their business resulting from the pandemic’s economic fallout. The majority of respondents also believed that the virus will affect commercial real estate performance into the second half of 2021 or longer. Notably, the bulk of respondents viewed overall economic conditions as negative, even though the Fed has taken unprecedented steps to make cash cheaply and readily available for banks to make loans.

In a June 2020 interview with S&P Global Market Intelligence, Stephen Scouten, a research analyst with investment bank Piper Sandler, said that banks have reacted to the market with extreme caution, especially to loan proposals from new clients. Bankers, he said, were unsure what losses would occur in their existing books and thus were not doing many new loans.

Investors and lenders can’t use the accepted norms to assess the value of a hotel, so even some deeply discounted deals may not be financed and go forward. A new approach to evaluating a hotel is needed.

What lies ahead?

As of November 2020, COVID-19 cases were again spiking across the country. It was reasonable to assume that the fortunes of the commercial real estate market will continue to deteriorate in 2021. 

Commercial mortgage brokers, however, will still have opportunities in a changing market, even though the financing options will be more limited. Many assets will be repositioned in the years to come. Office buildings will continue to have high vacancy rates as a second round of virus-induced shutdowns is in sight. Some owners will seek to convert underperforming malls and hotels into warehouse space or apartments. 

Many retail owners in major metropolitan areas such as New York City are already considering converting their assets into coworking space. This will create a completely new real estate asset class — retail coworking. The landscape of commercial real estate will change. Many big market players will go under and new ones will emerge. The ones that excel will find a balance between patience and aggressiveness.

Commercial mortgage brokers with extensive knowledge of the capital markets and a network of nonbank lenders will prevail. Brokers will need to filter through many alternative lenders to find those that provide good terms for their investor clients. Some alternative lenders may use these times to trap investors into loans with unfavorable terms. It’ll be up to brokers to serve as financial advisers to borrowers and prevent this from happening, even if it means lost commissions. Brokers who embrace the challenge and think long term will build strong relationships with their clients.

Brokers who solely rely on relationships with banks are likely to go under and should expand their network of alternative lenders. Broker expertise will be invaluable to investors who are scrambling to secure financing for new purchases, as well as existing clients seeking to restructure their current debt on underperforming assets. ●


  • Farrukh Hasanov

    Farrukh Hasanov is co-founder and CEO of Hasanov Capital. He is an experienced entrepreneur with more than 10 years of experience launching and managing successful businesses, including two retail pharmacies in Brooklyn, New York, and security-integration consulting company NeoRising Technologies. Hasanov also is an active real estate investor specializing in acquisitions, repositioning, refinancing and sales of multi-family properties.

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