What is changing, however, is how commercial properties and associated loan transactions are underwritten; under what circumstances and conditions they are approved; and how loan closings are conducted. These uncertain times are reshaping the lending process and this affects how easily commercial mortgage brokers can secure financing for deals. Some of these developments are positive and will be long-lasting.
Importantly, the pandemic has resulted in significantly limited foreclosure and eviction proceedings around the country, which is tying up distressed properties while the health crisis continues. Initially, these restrictions started as executive orders handed down from governors in multiple states. Some states, such as New York and California, turned these executive orders into law. Other states are expected to follow their lead. These moratoriums prevent lenders from acquiring collateral in a timely way via the foreclosure process and they prohibit landlords from evicting a tenant.
This puts lenders in an awkward position, creates a domino effect and changes how credit should be extended for new deals. If a tenant fails to pay, they stop paying their landlord. If a landlord is not collecting rent payments, they cannot pay their lender. With no federal relief for property owners or lenders, this leaves conventional and private lenders alike holding the bag, with no recourse as they had in prior years.
Given this situation, private lenders will likely continue to tighten their criteria in the coming months or possibly longer. Some lenders are treating long-term loans more like short-term bridge loans by collecting prepaid interest or interest reserves during this period of uncertainty. For example, collecting an interest reserve for the next four to six months is not unusual under the current circumstances.
Lenders also need to place more scrutiny on how they structure deals. Since the recent foreclosure moratoriums and eviction laws directly affect commercial real estate and the tenants occupying it, some lenders are only lending to entities and also are placing a Uniform Commercial Code (UCC) lien on the borrower’s equity interest. The lien essentially allows the lender to lay indirect claim to specific collateral, such as real estate.
In this way, the lender can typically complete a UCC foreclosure despite any moratoriums and dispose of the property in a public sale. This increases leverage for the lender at a time that legal restrictions have tilted leverage in the borrower’s favor.
The logistical challenges posed by the COVID-19 pandemic also have made the typical loan process much more difficult, from performing appraisals to attending in-person closings. Appraisers often must inspect the real estate in a socially distanced manner while borrowers and lenders don’t want to crowd into a conference room to conduct face-to-face closings.
Fortunately, technology has been up to the task. As the pandemic has stretched on, everyone involved in a deal (lenders, mortgage brokers, buyers, sellers, etc.) have generally been able to overcome the hurdles via Zoom and other communications platforms. Meanwhile, virtual tools are making some tasks easier and faster to complete.
Too often, Wall Street hands down restrictive credit-box requirements that are then disseminated by note aggregators and investors to originators across the country.
Appraisers, for example, are using drones and other virtual-inspection tools to survey and examine properties. They are relying more on desktop reviews, tapping into the vast information available online. The use of e-signing and e-notarization document services allow deals to close while adhering to health and safety guidelines.
Although laws in many states have not caught up with the times, the adoption of new technologies (such as the use of drones in e-appraisals and e-closings) are likely here to stay. In many places, it’s simply a matter of cementing temporary executive orders into permanent laws.
Lenders are learning how much faster it can be to reach the finish line and many are rooting for the permanent adoption of these improvements to execute loan closings. With many tools already in place, change will come quickly and eventually become commonplace. This is obviously a highly desirable outcome that should be around long after the pandemic ends.
Given the additional risks in this environment, lenders have been asking for more guarantees when making loans. What these guarantees look like depend on the lender’s preferences and the deal type. Some lenders may ask for higher interest reserves, the creation of special-purpose bankruptcy remote entities, additional collateral, the use of a UCC loan structure or lower leverage levels. Some lenders also have been opting to work with their borrowers to allow repayment deferrals as a way to avoid bankruptcy or foreclosure proceedings.
Although these new lending parameters may sound extreme compared to previous downturns, private lenders must find ways to protect themselves and their investments. The provisions mentioned above often become the norm as the market enters a downturn. Your clients will typically understand why these changes are necessary during this period of uncertainty for the market.
It’s also important to remember that changes to private lending are cyclical. Lenders react quickly to market shocks. These adjustments are not necessarily permanent, but they are essential for making deals happen during periods in which lenders are tightening their belts, and when the law does not extend protections or relief to these lenders.
Even with all the changes to commercial mortgage lending ushered in by the COVID-19 pandemic, it’s important to remember that these shifts did not begin with the health crisis. Many of the issues affecting commercial mortgages were merely accelerated by this unprecedented event.
A greater reliance on technology would have come naturally, especially the adoption of virtual closings to ensure that borrowers and lenders close faster and more efficiently. Meanwhile, for many brick-and-mortar retailers and some office properties, COVID-19 was simply the final blow in a slow decline.
As the country moves past the pandemic, lenders and borrowers should anticipate continued changes in lending guidelines and requirements. Commercial mortgage brokers need to speak regularly with their lenders to learn about credit-box criteria and also to let lenders know what they’re hearing from prospective borrowers.
Too often, Wall Street hands down restrictive credit-box requirements that are then disseminated by note aggregators and investors to originators across the country. Originators then wind up looking only for deals that fit neatly into these boxes.
As competition for loans increases, feedback from borrowers to mortgage brokers, from brokers to lenders, and then up to aggregators and Wall Street leaders could expand these credit parameters. This could make for a more diverse group of closed loans, which will increase the transactional activity for all companies and individuals involved. This can only be accomplished with open communication between originators and their funding sources.
These innovations were always expected to arrive in the commercial mortgage industry — the only question was when. The COVID-19 pandemic simply forced them to be implemented earlier than many in the industry expected. ●