Commercial Magazine

Shifting Markets Offer a Sense of Apprehension

Dangers exist as lenders transition from residential to commercial real estate deals

By Ryan Walsh

It was a wild and unexpected ride for the real estate industry in 2021, with mortgage lenders and brokers on both the residential and commercial sides of the business experiencing strong demand in nearly every category. And this year is looking to be just as crazy for market participants — but with a twist.

From one perspective, the mortgage industry is in the midst of an unprecedented shift. For the first time in many years, lenders are migrating their marketing and business models away from sales of single-family homes and the refinancing of mortgages in the residential sector to focus their resources on commercial properties. They are looking to lend on office space, multifamily housing and other commercial investment properties. This shift is due to the perfect storm of low interest rates, low inventory and high prices.
This shift began last year when commercial real estate assets were selling amid skyrocketing prices. Data research firm Real Capital Analytics reported that U.S. commercial real estate saw a year-over-year price increase of nearly 16% in October 2021, the largest such jump in the history of the company’s index. In the first 10 months of 2021, investors purchased $523.8 billion of commercial assets, up 70% from the same period in 2020. And according to research site Apartment Guide, one-bedroom apartments experienced a yearly rent-price increase of 21% in November 2021.
At the same time, residential home prices are showing signs of evening out after reaching year-over-year increases of about 26% in May 2021. By October of last year, annualized price increases had fallen to about 13%, according to Redfin.

Housing-market changes

For decades, the model for residential mortgage lenders has been to focus their marketing efforts on people between the ages of 30 and 40 who are looking to buy their first homes. This model worked great when interested homebuyers enjoyed medium or low interest rates, and there was a decent selection of reasonably priced homes to choose from in desirable areas.
What happens, however, when these same young adults are no longer interested in buying but instead are choosing to rent? Since the onset of the COVID-19 pandemic, the consumers who have served as the target audience for residential mortgage lenders are choosing to rent because limited inventory has meant that they can’t find their dream home — and they don’t want to overpay for a home that isn’t.
Some industry observers say that one reason for high home prices and a lack of inventory is the growing number of pension funds, investment firms and Wall Street banks that are snapping up available homes. According to Redfin, more than 18% of all U.S. homes sold in third-quarter 2021 were purchased by investors. The result is that banks are hedging their bets that renter households are going to grow exponentially compared to new homeowners. These lenders believe that their new clients will be investors and landlords who are qualified to buy high-priced homes with low-rate loans and turn them into rentals.

Looking for alternatives

With for-sale supplies of residential properties sinking to (or near) all-time lows across the nation, there simply aren’t enough prospective deals for residential lenders to sustain their personnel and overhead costs while keeping up with lower sales volumes. The logical business move is for real estate companies, banks and other lenders to shift their focus to the growing commercial-purpose space for rental housing.
It’s possible that a major price war will emerge as lenders race to provide the least expensive capital and the highest levels of leverage. Now is the best time to borrow money while there are lenders are competing for business. Any investor who has a good credit score and experience with previous rental properties is miles ahead of the game right now and will have banks competing for their business.
Many lenders will tell their broker partners that the outlook is good for the commercial space in 2022, but it’s likely that we are entering uncharted territory. This is the first time that many lenders have experienced such a massive and decisive business shift from residential to commercial lending. With the market as hot as it was in 2021, banks are finding that this is the correct business shift, but it’s still too soon to tell if this new model will continue to be profitable.

Spot warning signs

In the recent past, loans that could have gone sour have been saved by market prices that rose by 25% in less than a year. This also has allowed borderline deals to become good deals and for good deals to become home runs. Even vacant retail stores can be sold for a profit right now. But what will a cooling or bear market for real estate mean for those who have piled into the commercial space so quickly? No one knows, but we will quickly find out whether the infrastructure for commercial mortgage lenders is a house of cards.
The current “let the good times roll” vibe has the potential to come to a screeching halt. With low interest rates and high amounts of leverage, the current market has the potential to end badly for banks and private lenders that have been trying to fill a quota rather than make a smart investment. If lending institutions have been overleveraging their clients, it will quickly become apparent when a downturn arrives and defaults begin to occur.
Without enough money coming in due to lower interest rates and the simultaneous over-leveraging of assets, lenders of all types may have to take massive, unsustainable losses on investment properties that can no longer perform. If the market starts to cool, keep an eye out for more mergers and acquisitions as some companies begin to buy out other lenders. This may be the first indicator that overhead costs can’t be paid and that these lenders are getting out while they still can.
In the early days of 2022, the real estate market is looking new, exciting and heavily dependent on home-price increases staying steady or increasing rapidly to remain on its profitable trajectory. If the current pace continues, expect to see more rental homes popping up. On a more dour note, if the housing market turns into one that favors buyers, mortgage brokers and their clients can expect to see interest rates rise quickly and high-leverage loan offerings to start deteriorating.
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The extent to how high interest rates go — and how low leverage goes — will be dependent on how quickly the markets turn. If it is a slow, healthy shift back into a buyer’s market, the mortgage industry is likely to see a nice balance of commercial and residential lending by the end of 2022.
If it is a sharp shift to a buyer’s market, however, we may see a less severe version of the 2008 recession if banks turn out to be over-leveraged. It is best for mortgage professionals to stay vigilant. ●


  • Ryan Walsh

    Ryan Walsh is a managing partner at the Greater New York City-based Hard Money Bankers and is an entrepreneur of multiple successful companies. He originally used private money to expand his own enterprise, then realized the importance of private money for growing businesses more quickly and easily.

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