By Elliot M. Shirwo, Founder and Principal
BridgeCore Capital, Inc.
Undeniable COVID-created inertia is driving the commercial real estate market today, with innovative approaches surfacing to consummate transactions.
The fear and anxiety, hope and fulfillment of dreams, and confusion and uncertainty being felt by society as a whole, are certainly impacting those invested in the commercial real estate life cycle.
Sellers, buyers, lenders and borrowers all are experiencing the impact of the worldwide pandemic pause. It’s impossible to escape.
On one hand, sellers fear that the longer their properties are on the market, and as the pandemic and recessionary economy linger, values will decline.
On the other hand, for many sellers who see the glass as half full, they hope and envision values quickly will increase, as the pandemic wanes and the U.S. economy fully reopens.
Buyers want the economy to reopen quickly, yet they hope the stalled economy will give them leverage to negotiate lower pricing on transactions.
Borrowers wish they will be able to secure forbearances from their lenders, but fear that this relief may be short-lived. If the economic impact lingers, even when businesses fully reopen, many tenants – especially retailers selling to consumers – may still be unable to pay rent for several months. This, in turn, will negatively impact a given property’s net income, and ultimately, its short-term resale value.
Fully aware and fearing that time kills deals, lenders and mortgage brokers are mediating between countervailing forces and the immediate, innate need to keep transactions moving forward.
At the same time, many lenders have put deals on hold, grinding to a halt promising transactions in a not-that-long-ago flourishing landscape. Lenders that have chosen to remain active have been overwhelmed with bottlenecks, as their production pipelines crawl through obstacles created by current market dynamics.
So, where does this leave everyone? Confused for sure, and in many cases, paralyzed by the unexpected and far-reaching nature of current events.
Despite this confusion and paralysis, options abound for the market to move forward.
This is where private debt comes in. Private money lenders offer viable solutions for the commercial real estate market – for borrowers and brokers, lenders and investors – to get deals done quickly and efficiently.
Why private debt?
Private money lending has always thrived during economic downturns.
While the coronavirus pandemic and its widespread economic effects are historically unprecedented, tightening standards and restricted liquidity in the conventional lending space are not new. During cycles when conventional lending opportunities contract, private lending expands, as borrowers and investors alike look for new options.
It’s important to note, however, that private debt is not fully immune to the damage caused by the severe economic impact of COVID-19. In the last couple of months, a number of private debt funds and capital providers either temporarily or permanently shuttered their operations due to a freeze of their capital sources, poor underwriting practices, and/or non-performing loans, resulting from a coronavirus-related forbearance or default.
For those that are fortunate to be actively lending today in the private debt environment, the landscape is riddled with market delays, stemming from rate renegotiations, expanded due diligence, short- term extensions on maturing debt, re-underwriting loans, and arbitraging greater spreads for investors. In addition, since private money – perhaps wrongfully so – tends to be the choice of last resort, there’s the perennial shopping for cheaper debt by traditional lenders.
Despite those unavoidable delays, most purchases and refinances currently in the market require the execution speed that only private lending can deliver— agility that is proving quite beneficial.
For example, we are seeing a significant number of cash-out transactions, as some borrowers seek to inoculate their operating businesses with cash infusions to get them through the current economic hurdle.
Some borrowers are looking at this time to expand their financial coffers in anticipation of ready-made, perhaps even unprecedented, shopping spree opportunities of distressed, but quality, real estate assets.
Other borrowers may be preparing for what they believe could be a slow reopening and reintegration process, or a second wave of reinfection and more closures in the coming fall or winter seasons.
How private lenders are navigating the landscape
Private lenders are approaching the new market challenges in new and different ways.
Some private lenders are pressing the pause button to focus on managing their existing portfolios and negotiating workouts on any non-performing loans.
Others are actively transacting, but they are implementing modifications to their existing guidelines. Today’s “new normal” in commercial real estate may include all or a combination of the following:
- Price increases
- Reduced loan-to-value thresholds
- Removal of vulnerable property types, such as retail and hospitality from their pipelines
- Reduced or eliminated subordinate financing
- Requiring or increasing interest reserves
- Applying full recourse in instances where non-recourse was the normal
Another group of lenders is choosing to not make any changes. They continue with a business as usual mentality, enduring the delays and disruption, and not adjusting for any perceived new market risks.
The impact on underwriting
For mortgage investors, risk lies squarely within valuation. Without an accurate determination of value, lenders cannot assess how much coverage exists to protect their investments.
The pandemic and its ensuing uncertainty have put that age-old instinct of preservation of capital to the test.
Prudent private lenders aren’t standing by to see what happens. They are adjusting their valuation methodologies and underwriting standards to ensure that there is ample equity coverage to account for the new economic, political and societal stresses on property values.
These risk-based adjustments include, singularly or in combination:
- A blanket 20% discount on pre-COVID-19 values as a basis for as-is valuation
- Increasing underwriting assumptions, including vacancy rates and expense ratios
- Making cap rate adjustments
How long these pandemic-induced changes to underwriting practices and lending guidelines will continue remains to be seen.
The private money advantage
Unlike traditional lenders who are hampered by the burdens of federal regulations, private lenders are nimble and can pivot to meet a range of market demands and unique circumstances.
Whether a borrower is seeking speed of execution, a short-term bridge to traditional financing, creative loan terms, or a solution for personal hurdles, such as foreign national status, limited liquidity, bankruptcy, or a low credit score, private money always has served, and will continue to meet, specific needs in the market.
During COVID-19 and the ensuing period of economic recovery, private lending for the commercial real estate market will continue to further solidify its position in the capital markets as an irreplaceable, solutions-focused financing strategy.
With the inertia-busting agility of private debt, along with the guidance of experienced, trusted mortgage brokers and advisors, commercial real estate investors and developers can continue to move forward and thrive, even in the midst of a global pandemic.