Commercial Magazine

Survive in a Tougher Market

Brokers must be willing to consider new property types and locations

By Rob Diodato

These are trying times for commercial mortgage brokers, lenders and borrowers alike. The post-coronavirus commercial real estate market will be far different than the one in March 2020 prior to the pandemic.

Before the crisis, it was easy for the typical broker to get complacent. The market seemed to be on a long, unimpeded run as we entered this year. The values of many commercial asset types hit record highs as a result of the Federal Reserve stimulus and historically low interest rates propping up the market. Today’s market is much different, however, and many companies are facing a day of reckoning. Brokers will struggle to stay in business if they do not expand beyond their traditional territory and broaden their focus to include multiple commercial real estate asset types.

Seasoned commercial mortgage brokers who weathered the previous financial crisis during the Great Recession understand that you must diversify and remain flexible to survive and thrive in a fluctuating market. They also know that with every crisis, the commercial real estate market emerges on the other side of the cycle with added opportunity.

The financial crisis of a decade ago devastated the market for several years, but it also spawned the growth of the private equity market in commercial real estate. Likewise, the savings and loan crisis of the 1980s pummeled the commercial real estate market, but that led to the birth of commercial mortgage-backed securities. Each of these events increased the financing options for the mortgage brokers who survived.

Commercial real estate bubbles that burst, as well as Black Swan events such as COVID-19, typically thin the herd of commercial mortgage brokers — especially those who focus exclusively on one segment of the market or on a single geographic location. A broker who finances multiple asset types across several locations has a distinct advantage today. Certain geographic areas are not impacted as greatly as others and some segments of the market are flourishing despite the challenges.

Commercial real estate bubbles that burst, as well as Black Swan events such as COVID-19, typically thin the herd of commercial mortgage brokers.

Tougher standards

Today’s mortgage broker has to work harder to get deals approved. Now more than ever, it is important for brokers to vet clients. 

Lenders are scrutinizing a borrower’s business or employment income. If a borrower entered into a forbearance agreement on their commercial mortgage, home loan, auto loan or even credit cards, lenders are walking away from these borrowers and their corresponding deals due to concerns about the borrower’s ability to repay a loan. Lenders also are more carefully evaluating the borrower’s property holdings and payment history.

Additionally, lenders are wary of current or recent hot spots for COVID-19, and states where reopening phases have been delayed or rolled back. Many lenders have stopped funding deals in areas with spikes in coronavirus cases, since it raises the lender’s risk if the state is shut down again. This is akin to virus-related redlining, and it will certainly be prevalent until an effective vaccine has been introduced.

Lenders also are taking the same wait-and-see approach on properties where tenants are starting to reopen their businesses. They want to see several months or more of revenue data to determine how these properties will perform compared to the past. Before approving a loan, the lender wants more assurance that the property will do well, regardless of whether the property is owner-occupied or leased.

To survive as a broker in this new environment, you must first determine the lender appetite for each asset class and any guideline changes being imposed, and then market for these types of deals. For the most part, lenders are now wary of higher-risk property types in specific locations, such as office properties in urban areas. Hotels and restaurants, among other niche property types, will face challenges for some time. Lenders will gravitate away from high-risk assets for the foreseeable future. Retail also will struggle as the pandemic has conditioned more people to shop online. Many retailers will likely close or enter bankruptcy.

Another likely casualty is the small business. As the health crisis drags on, more mom-and-pop businesses will fail. This will make it far more difficult to finance unanchored strip retail and small mixed-use properties. Many of these small-business owners also are home-owners. So, the devastation could eventually spill over to the residential sector. Multifamily will face some headwinds if federal stimulus efforts end, businesses shut down and unemployment remains high. Moratoriums on rent payments and evictions have already put pressure on apartment owners.

To survive as a broker in this new environment, you must first determine the lender appetite for each asset class and any guideline changes being imposed, and then market for these types of deals.

A wider focus

The key to getting a deal funded is to focus on property types and locations where lenders are still active, albeit with more conservative terms. Importantly, brokers must clearly explain to borrowers the realities of this much tighter market. Your clients need to have realistic expectations, and be prepared for the extra scrutiny and security lenders now seek, such as requiring the borrower to keep enough cash in reserve to cover 12 months of principal and interest on the loan.

Brokers who specialized in a particular asset class in one city before COVID-19 could struggle to stay in business. Take the example of multifamily assets in New York. Prior to the pandemic, there were ample financing options and a seemingly insatiable appetite from investors to buy apartment buildings. Those days are over. Some lenders will still finance multifamily properties in New York, but the property must have a good operating history and an owner with extensive experience. The borrower also must be willing to take a loan with more conditions.

Some lenders in New York also are gravitating to the abundant rent-subsidized sector for the implied guarantee of rental income. To finance these deals, however, brokers have to look harder for lenders, and establish relationships with nonbanks that specialize in interim and bridge financing.

For the foreseeable future, properties that include essential businesses will have a far better chance of obtaining financing than those without. Property owners who have entered into forbearance, whether on the subject property or any other holdings, will be viewed negatively by lenders.

Preferred assets 

Certain segments of the market, however, are thriving in this environment. The outlook for the single-family rental market is excellent. Renters are fleeing densely populated urban areas for single-family rentals in the suburbs that afford privacy, social distancing, a yard and perhaps a pool. Financing is readily available on multiple fronts for the single-family investor market, including fix-and-flip, buy-to-rent and portfolio mortgages. 

Another segment of the market with increased investment activity is the single-tenant, triple-net lease space (also known as NNN), although not all tenants in this market appeal to lenders. Those that do include Dollar General, Dollar Tree and Walgreens, just to name a few. Typically, the loan amounts are higher in this space and the deals are larger. So, if you turn your attention here, you can close fewer deals and still succeed.

Another niche sector that remains in favor with lenders is medical-practice financing sought by doctors and medical professionals to establish a business. Sometimes, the client wants to finance a commercial condominium or co-op. Other times, it may be for an entire building. These types of deals can include financing for build-out or equipment. In this space, the U.S. Small Business Administration tends to offer mortgages with higher loan-to-value ratios. 

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For any brokers who limited their financing programs in pre-COVID times, this is a great time to expand into other asset classes and offset the loss in revenue from other segments. Brokers who have been lending in multiple states and on various property types will not just survive, but thrive, and with less competition. 

The new mantra is “evolve or die.” Brokers who reposition themselves and offer financing for multiple property segments and locations will see continued growth. ●

Author

  • Rob Diodato

    Rob Diodato is the president of York Commercial Finance, a commercial mortgage advisory company with offices in Dallas and New York. Diodato arranges financing for commercial real estate transactions nationwide for all property types. Diodato has more than 26 years of experience in the commercial and residential mortgage industries.

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