Fickle – that’s one word to describe the commercial real estate market as the COVID-19 pandemic winds down and the accompanying economic development downturn looks likely to take 18 to 24 months to resolve.
For individuals or companies wanting to buy or build commercial real estate (CRE) properties, there’s money available – for the right person, with the right deal and at the right time. If those factors fall into place, there’s conventional loans available from banks and other lenders, as well as Small Business Administration (SBA) loans.
But the market at the end of Q2 2021 isn’t taking risks. There’s not much speculative lending for anyone without a solid track record, which means borrowers who have built or bought CRE before, understand the market, and have the proven ability to repay loans.
“I’m seeing a very good availability of financing in the market,” said Jeff Pori, founder and CEO, Kingsbarn Realty Capital. By financing he means everything from bridge loans (short-term financing used until the borrower can secure permanent financing) to gap equity loans (between short-term and permanent) which are prevalent. And the CMBS market—commercial mortgage-backed securities—has come back from pandemic days, “It [had] basically shut down for a few months and then, when it came back, it was unpredictable at best,” said Pori.
Leverage isn’t as high as it was, and it wasn’t all that high pre-pandemic. “At least compared to 10 or 15 years ago when you could regularly get 70 to 75 percent levels of leverage. It’s more like if you want good terms, you’re going to be down in the 55 to 60 percent leverage range,” said Pori.
Which means there’s a lot of financing available, a lot of monetary volume out there in the marketplace, but the market is still fickle, looking for the right deal at the right time.
Pandemics and Properties
Not all CRE properties have returned to pre-pandemic levels. “Borrowers who own industrial and multi-family are seeking and obtaining very aggressive loans, almost at the same level as pre-pandemic,” said Kyle Nagy, director, CommCap Advisors. “Other property types, retail and office specifically, are not at pre-pandemic levels yet. There’s more caution around those property types.”
Retail and office often lag industrial and multifamily in recovering from an economic downturn. And with the pandemic-caused downturn, office and retail were hit immediately, because people weren’t going to work, and they weren’t going shopping.
“It’s not necessarily economic distress, all property types suffer,” said Nagy. “It can be economic distress specific property types, individual property types, suffer. Prior to the pandemic we were able to lend at 70 to 75 percent loan-to-value on office and retail. That was a traditional loan-to-value request, lenders were there, and they were competitive and able to close these types of transactions.” Post-pandemic, specific retail and office properties have lower loan-to-value, so instead of 75 percent it might be 66 percent.
When deals are made, they’re being made fast. Interest rates fell to, in some cases, below 3 percent over the course of 2020. The volatility of the market creates a complication for lenders, though. The period between putting a deal together and signing documents needs to move faster. Because that’s the time lenders are most at risk.
Lenders move faster to limit exposure. “So, when they close on a loan, before they sell it, that time period is when they’re exposed to changes and conditions, so they really have tried to close loans very, very close in time to when they’re going to bundle and sell them,” said Pori. “They’re trying to bring things to the market very quickly at lower leverage levels, and they’re very much leaning on tenants that are creditworthy. They’re not very speculative at all right now.”
Building and Buying
In the current market, someone looking to buy CRE property is probably looking for a stabilized, income-producing asset like a multifamily apartment project or a retail center where people buy clothes and have lunch. And financing is available, said Nagy.
Buyers for commercial property are looking for permanent, full-term loans, generally with a period of 10 years. When looking for permanent financing on CRE, there are options. The ones most people lean on are either the CMBS market, or life insurance companies. “Those are the two that are most typically used for permanent financing on deals that have any kind of scale to them,” said Pori.
Most investors wanting to build office, retail or multifamily property go to their local bank. “These are the institutions that provide typical construction financing,” said Nagy. “They’re still lending in the marketplace, and properties are being built, and they’re lending on traditional property types. There’s no question, local banks are far more aggressive on industrial and multifamily than they would be on office or retail.”
Traditional conventional bank financing has less favorable terms than other forms of financing because bank loans are recourse loans. Life insurance loans and CMBS are nonrecourse, meaning there’s no personal guarantee required. “You’re only exposed for what they call the bad boy carve-outs, if there’s fraud or environmental problems, things like that on the property,” said Pori. Banks also often have 25-year amortization schedules, where CMBS and life insurance companies generally amortize over 30 years. “That difference between a 25- and 30-year schedule makes a very big difference in cash flow to the property.”
On the more traditional investment, multi-tenant properties side, the only government programs are for multifamily, Nagy said. Those are HUD programs, Fannie Mae and Freddie Mac. But there are SBA 504 community development loans. The
economic downturn and sky-high unemployment numbers didn’t cause the devastation CRE lenders expected. Government programs like Paycheck Protection Program (PPP) helped keep businesses up and running.
“I was concerned that we would see a lot of defaults within the real estate market on our current clientele and people that have loans outstanding, and that was kind of what we were ready for, but we actually saw the opposite,” said Evan Dickson, president, Nevada State Development Corp. “We saw people who wanted to expand, businesses that were still doing good and wanted to grow and wanted to buy their commercial real estate. So that was a welcome surprise.”
Nevada State Development Corp is a certified development company (CDC) authorized by SBA to market, underwrite, process and service the SBA 504 loans. It exists to assist small businesses in acquiring owner occupied CRE with as little as 10 percent down.
“We’re extremely busy right now,” said Dickson. With programs in place to help business owners buy CRE, and programs that made some monthly payments on SBA loans that were outstanding during the pandemic, more businesses made it through this downturn than, for example, the 2008 recession.
“I know for a fact [those programs] helped them make it through that period of time,” said Dickson. “But I was surprised at how many loans we’re doing. Typically, in a year we do between 50 and 60 loans. We’re about three-quarters through our fiscal year and we’ve submitted 70 loans to SBA. We still have four months to go. Based on that volume, it’s crazy on the SBA side.”
Possibly, the high increase in SBA loans is because, when the downturn hit, a lot of financial institutions took a step back, not wanting to be at higher loan-to-value on collateral. “That’s where the 504 program comes in and allows the banks to be at 50 percent loan-to-value and we pick up the remaining part through 504,” said Dickson. “That might have been a lot of what helped stimulate businesses, too, that and the fact that our interest rates were below 3 percent.”
Over the course of 2020, interest rates dropped quite low. “We’ve been seeing conventional loan pricing in the fours, in that area of coverage, and there are some institutions out there that are much more aggressive than that right now,” Dickson said. “We’re seeing them lock in some of those periods for, a lot of times, up to a 10-year period. That’s aggressive pricing going into everything. If you get a rate at a bank to buy with our rate below 3, you could be below 3 percent financing right now. How long will it hold on? Who knows? I would expect to see increases as we move forward, but I don’t think it’s going to be a huge increase. I just don’t think that they would do that to the economy at this point in time. I think they’ll wait until we’re a little more stable.”
By comparing January 2021 to January 2020, Nagy said there was a considerable shift in interest rates. It’s difficult to predict where rates are going or where they’ll be at any specific time. “But they have stabilized here for the last couple months, and stayed within a certain range, which brings comfort and security to the lending marketplace.”
Pori added that rates have already shot up this year when President Biden took office. “The rates that a lot of our loans are based on are either the treasuries or the swap rates, and when Biden took office, swap rates, for example, were down around 80 or 90 basis points. They quickly doubled after he took office and the spreads that the lenders price over the swaps or the treasuries, they widened as well.” Swap rates are contracts in which one party agrees to pay a fixed interest rate to another, in exchange for receiving variable rates.
Since President Biden took office, the market has stabilized and rates are hovering, and have been for about two months, said Pori. That’s a good thing, because committing rates when things are moving quickly is hard for lenders. A more stable market is more comfortable for them to lend in.
Money to Lend
As interest rates are expected to climb and market volatility slows, there’s money to be lent. A lot of it is some of the riskier money because the market isn’t feeling speculative. The money available is either for people with very established track records and credit histories or for those seeking SBA loans.
“Conventional is still out there, but they’re going to want to be at 70 percent loan-to-value in a lot of cases, which means you have to come up with 30 or 25 percent. Then there’s always the 504 program which basically picks up the difference from the conventional loan and lets the bank come in at 50 percent and a lot of cases, we can do an additional 40 percent, so the borrower only has to come in with 10,” said Dickson. “Either way, it’s out there, and it’s just a matter of reaching out to your banker or reaching out to your CDC to move forward.”
In CRE, track record means the borrower has owned CRE before and understands it. If those prerequisites are in line, there’s money to be loaned. But if either the borrower or the property isn’t considered stable or creditworthy, the loan may be considered too risky in this not so speculative market.
“Sometimes when there’s so much money out there, things start to loosen up because the money is wanting to be deployed,” Pori said. “But I really don’t see things loosening right now.”
“There’s a greater degree of uncertainty out there,” said Pori. “Are we concerned about more pandemics? I’m sure some people are, and some people aren’t. That’s just one more variable that’s been added into the marketplace now, one more risk factor.”
One more risk factor in a marketplace where lenders are very risk adverse in the first place. Lenders like everything to be business as usual, Pori said; they like normal. So, the fact that most industries are still feeling the effects of the pandemic today, and the fact that it’s not over—headed that way, but not over yet—means that some of the effects we’re feeling are going to have lagging indicators.
“Meaning that some of the problems that have occurred may not have manifested themselves all the way yet. There’s a very cautious approach lenders are taking to the real estate market right now, and it’s not just the pandemic anymore,” said Pori. “There’s also some inflation concerns, so that’s another thing that’s probably going to impact the market significantly going forward. We expect interest rates are going to eventually start to creep up as inflation takes further hold. And we feel very strongly that we are in an inflationary cycle, and we expect that’s going to continue for a period of 18 to 24 months, if not longer.”
Dickson expects interest rates will go up in 2021, but not dramatically. “That’s not going to be beneficial to the economy and I don’t think anyone wants to force that into the situation right now. But they can’t stay low forever, and I don’t think they can go much lower. But we are seeing aggressive programs out there by some of the banks where they’re trying to get some money on the streets. That’s a good thing.”