How COVID Has Changed CRE Lending
Debt Markets Are Improving by the Day
by Cynthia A. Hammond
Capital allocated to lending on commercial and multifamily real estate is plentiful today, especially for individual investments of over $30 million. The COVID shutdown caused lenders and investors to pull back from originating loans in the 2nd & 3rd quarters of 2020. As recovery from the COVID induced recession commenced, investors were awash with capital to be placed in commercial real estate debt. This was caused by existing funds allocated to commercial real estate (“CRE”) debt that was not invested in prior quarters, and new money being allocated to CRE debt and equity. Some lenders found themselves short staffed, as key staff had changed jobs during the recession, or were reassigned out of loan originations.
Faced with large investment goals and limited staff, many lenders have increased their minimum loan size. In our survey of 40 middle market life insurance company lenders, 27% increased their minimum loan amount in 2021 to over twice the prior year’s minimum loan, from a 2020 average of $7 million minimum loan to a 2021 average of $15 million. Still, 19 life companies in our survey are actively making loans of $10 million or less.
These small to mid-sized life companies generally lend through correspondent mortgage bankers in local markets. These mortgage bankers originate, underwrite, and often service the loans for their life company lenders. For a borrower to obtain a loan from these companies, they would work through the correspondent mortgage banker. The life companies generally charge zero or minimal loan origination fees, and the mortgage banker obtains an origination fee for the loan, paid by the borrower. These lenders generally will not take a loan from the borrower directly. Many do not require repayment guarantees.
Different Approaches to CRE Lending
Lenders writing smaller commercial property loans of under $15 million are composed of banks, life insurance companies, agency lenders and securitized CMBS lenders. Many national banks
have reduced or reached maximum capacity for construction loans, especially on multifamily properties, and are now competing head-to-head with life insurance companies for fixed interest rate loans of 3-10 years, often with minimal fees assessed for early prepayment of the debt. Community banks are stepping in to the gap, writing construction and permanent loans, both with personal guarantees. However, some will require no repayment guarantee at a leverage of 55% +/- loan to value or less.
Life insurance companies emerged from COVID with different approaches to CRE lending. Interest rates dropped sharply in 2020, with the 10-year Treasury bond yield dropping from 1.88% on 1/2/20 to a low of .54% on 3/9/20, to 1.57% on 5/9/21. CRE loans are generally priced off the 10-year Treasury yield, and/or in comparison to corporate bonds of similar risk. Faced with very low rates on newly originated CRE loans, some pivoted their loan program to writing “bridge-light” loans, with interest rates fixed or floating of 3% or more. These 2 to 5-year bridge loans are made for a property in transition, with light value-add work to be done, and existing cash flow that can cover debt service on an interest only basis. Others are making fixed rate construction/permanent loans, heavy value-add bridge loans or mezzanine loans for new construction of multifamily or industrial properties. The majority of life companies decreased their maximum loan value to be closer to 60%, and offer very low fixed interest rates in the mid to high 2’s for leverage of 55% or less. Select life companies are writing non-recourse permanent loans at 70-75% of value, with 10 year fixed rates generally at 4% +.
CMBS lenders became active again beginning in the 4th quarter of 2020, following a 39% decline in volume in 2020 from 2019. Commercial Mortgage Alert published a survey of 19 lenders and other industry pros, who predict a 28% increase in CMBS volume in 2021. Year to date, U.S. CMBS volume is 14% higher than 2020. Representative rates for a variety of loan and lenders are shown below.
What Are the Desired Asset Types?
Property types most desired by lenders are industrial, multifamily, self-storage, and medical office. Less favored are retail and office. For non-multifamily properties, most lenders are seeking diverse rent rolls with longer weighted average remaining lease terms or long-term leases with credit tenants generating sufficient income to cover debt service. CMBS lenders are filling in the gap in demand from life companies and banks to make non-recourse loans on retail and office.
Grocery anchored retail and well-designed retail strip centers are being financed by banks, CMBS lenders, and a subset of life companies. Life companies seek a grocer anchor, preferably on a lease with the borrower, who has strong sales and is either in the top 3 in market share in their trade area or is a specialty grocer like Trader Joe’s. Some life companies have specific expertise in understanding retail real estate, and are finding success lending on solid retail centers that may not have all of the most desirable characteristics. An example is a recent loan done by a life company on an established, very well located strip center in an affluent Chicago suburb anchored by a CVS and Ace Hardware. This center had long, strong occupancy history and an excellent location. The life company made a non-recourse 15-year loan with a 25-year amortization, at a rate in the high 3’s, with a rate re-set in year 10, at 68% of appraised value.
Industrial properties attract the greatest number of lenders and investors, and all are fighting to get their share of the business. Life companies will finance Class A distribution/logistics projects with very low interest rates and some will agree to close following completion while the property is in lease-up. Multi-tenant and credit single tenant industrial loans are being made by life companies, banks, and CMBS lenders with fixed rate terms from 3 to 25 years, at leverage maxing out at 75%, with the lowest rates for leverage at 60% or less.
Multifamily generally ties with industrial in lender demand. The agency lenders Fannie, Freddie, and HUD capture the lion’s share of multifamily loans, followed by banks, with life companies and CMBS lenders writing a smaller share of loans. Agency lenders are pushing mission driven initiatives that offer lower interest rates (10 to 30 basis points lower) for properties deemed affordable (including those not on government assistance programs) or “green”, where a minimum level of sustainable elements are present in the property. Fannie offers a sponsor initiated affordable program where a lower interest rate can be obtained if the borrower agrees to set aside sufficient units to meet the affordable income criteria. Freddie Mac offers 7 to 10 year floating rate loans with a 1% prepayment fee after 1 year, with rates in the high 2’s. This program is in high demand. Fannie and Freddie still require COVID reserves but are being more aggressive with selective waivers that reduce the reserve to 6 months of interest only payments. Life companies are competing with the agencies for multifamily by writing fixed rate construction/perm loans or closing permanent loans without any COVID reserves. Many are closing newly completed multifamily loans before stabilization.
Some life companies are now entertaining loans on single family rental homes on single or attached parcels. We surveyed life companies to determine who will lend on SFR rental homes. Seven out of 14 lenders have either lent on them or are evaluating the asset class. One of the life companies is presently closing a construction/perm loan at 66% loan to cost and 58% loan to value on an SFR rental community.
In summary, debt markets are improving by the day with a wide variety of lending sources allowing viable projects to obtain funding.
