As a commercial mortgage broker, it may be rare for you to see the pressures and back-office processes driving your lenders’ decisions. But the success or failure of your deal often depends on what has been going on behind the scenes.
Various forces are pushing commercial mortgage lenders toward greater efficiency and technology use. Ultimately, developments in your lender’s back office will change how commercial mortgages are originated, underwritten and serviced. To see why technology changes and greater efficiencies are inevitable, however, we need to take a hard look at the business of commercial real estate lending, and the areas where it needs improvement.
Commercial mortgage lending can be a brutal business. Bank margins for commercial mortgages are razor thin, but the typical lender also faces tremendous competition and pressures to make loans, however unprofitable. Loan pricing is often disconnected from the actual risk. The lender must try to squeeze the cost out of every part of the loan process.
And then there’s the ever-present pressure to be perfect. Given the thin margins, the decision to lend to a business-purpose borrower requires near perfection in all areas of the lending operation — including credit judgment, deal structuring and support of operational processes. Missing a small detail within a loan can translate into large financial losses. Even after a loan closes, a number of problems can arise. Additional costs in servicing the loan can pop up anywhere.
In general, a major problem with the commercial mortgage industry is that the process of making and servicing loans is antiquated, and is typically weighed down by manual and lengthy workflow procedures. The more manual these processes are, the more costs rise. The COVID-19 pandemic and the subsequent uncertainty it created for the U.S. economy have intensified the pressures on traditional lenders to find innovative ways to evaluate borrowers and make safe loans at lower costs.
The good news is that things aren’t all doom and gloom. Last year, commercial and multifamily mortgage lending volume was at a record high, according to the Mortgage Bankers Association. At the end of 2019, outstanding commercial debt rose by more than 7%, or $248 billion more than the debt level at the end of 2018. In the post-coronavirus world, the appetite for commercial mortgages will most likely bounce back. Meeting that demand, however, will require innovative responses from traditional lenders.
The terms of a commercial mortgage are not always based on a borrower’s risk factors. Rather, some lenders make their decisions based on what the competition will do.
It is worth taking a closer look at the typical obstacles and pressures that lenders face, which are driving changes. First, there’s competition. The typical commercial mortgage lender faces a growing number of nontraditional players, such as financial-technology companies (fintechs) and online lenders. As of 2018, there were more than 4,700 federally-insured commercial banks in the U.S., including 60 to 70 “mega” banks, as well as other savings and loan institutions that are crowding the market and competing for a piece of the pie.
Because of this environment, the terms of a commercial mortgage are not always based on a borrower’s risk factors. Rather, some lenders make their decisions based on what the competition will do. Commercial loan pricing is often considered a loss leader by many banks, and the largest lenders are sometimes willing to give the loan away to freeze out competition.
The ability of commercial lenders to compete depends on their ability to remove any obstacles that hinder their growth. One such obstacle is bridging the gap with the client. There is a human element in the loan process. Establishing trust has historically been an important factor in commercial real estate lending.
Lenders like to form relationships with the client and assume the role of a trusted advisor. Often, however, the lender puts time and effort into the wrong priorities, ignoring the areas that will actually improve the customer experience. Ultimately, a lender’s back-office systems and processes drive the success or failure of a loan proposal. When these systems are disconnected and inefficient, relationships with borrowers begin to dissolve.
Many lenders, for example, lack consistent and streamlined processes. The typical lender commonly uses multiple systems and vendors to originate, underwrite and service a loan — sometimes enlisting as many as 10 disconnected systems from the beginning to the end of a loan cycle. This approach means that the loan gets passed around to multiple people. Often, however, critical information about the loan is portioned out and siloed among various parties.
One cause of this is a widespread lack of digitalization, meaning that important information about the loan has been entered on a paper form that is filed away in an office. Antiquated, paper-based processes make it hard to share information and store it, adding time and expense to an already bloated approach. It is not too surprising then that borrowers in the U.S. tend to be less loyal to a commercial mortgage lender compared to borrowers in other countries.
A unique opportunity
Given the unforgiving environment, loan loss is an ever-looming threat to lenders. It also is driving more lenders to improve their back-office processes to minimize errors, eliminate redundancies and mitigate risks. In an industry with such a low margin for error, automation can become a game changer.
Automated tasks help to reduce manual errors while ensuring that a commercial lending team can support the work and meet its margin requirements. Capabilities such as application programming interfaces and auto- or prepopulated forms can make it easier to provide borrowers with a seamless experience.
Artificial intelligence (AI) also is transforming commercial mortgage lending. AI eliminates the most time-consuming, repetitive tasks, and frees up lenders to perform work that more directly improves the borrower experience and loan quality. Additionally, AI enables lenders to use data to learn patterns, diagnose problems, better predict behavior and even prescribe future behavior.
The time for a tactical investment in technology is now. The global health crisis made this obvious. Today’s commercial real estate lenders need to make use of digital technology to lend quickly, flexibly and responsibly in an increasingly uncertain world. If the traditional lender doesn’t do this, its closest competitors likely will. The most nimble and innovative lenders will use their technological advantages and efficient processes to quickly seize opportunities.
The drive toward change is inevitable because a new tech-savvy generation is on its way. Millennials are already taking on a greater role in borrowing and lending. Therefore, critical digitalization capabilities must become embedded into a mortgage company’s processes — especially the processes that provide what borrowers want. As these capabilities are adopted, the industry will deliver simpler lending workflows, faster underwriting and greater transparency for borrowers and commercial mortgage brokers alike. ●