Highly leveraged loans face high risk

Among the main categories of real estate assets, multi-family appears to be one of the strongest to date amid the coronavirus crisis. Despite some decline in rent payments, experts are confident that the combination of continued demand and limited supply will fuel a relatively rapid recovery. This always raises a key question: will the fundamentals be healthy enough for borrowers to get highly leveraged loans?

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Brian Salyards, Director, PGIM Immobilier. Image courtesy of PGIM Immobilier

It has been clear for months that conditions have changed dramatically. Lending for multi-family and commercial properties is unlikely to match the Mortgage Bankers Association’s record $ 600 billion last year, noted Jamie Woodwell, the organization’s vice president of commercial real estate research. , in mid-April. Although loans are still available, the spreads have increased and fewer lenders are providing quotes. In uncertain times, lending trends will depend on the length of the recovery and the speed of the economic recovery, Woodwell observed.

Despite the rapid exit of non-bank lenders from the scene, other sources are stepping in to fill the void, even as the impact of the COVID-19 outbreak worsens and affects the economy in general. “There are still active bridge lenders ”, said Shahin Yazdi, director of George Smith Partners. “Most low cost lenders cap at 65% loan-to-cost ratio, but there are private lenders that can reach 75-80% LTC.

The standards for a higher loan-to-value ratio will be familiar to those who have experienced past economic downturns. “The property itself must be located in a powerful metro, and there must be a clear indication that the rents are below the market”, Yazdi added.

Traditional lenders have also taken a step back, waiting for more clarity. During this time, “HUD and agencies are supposed to provide liquidity at all times, but especially during times when others have left the market” noted Brian Salyards, Director of PGIM Real Estate. HUD loans can come with some structure, such as a nine-month debt service reserve. That said, an LTV of 85% can still be achieved at very attractive rates, just under 3% plus a mortgage insurance premium on 35-year loans.

As part of their plan to navigate a volatile landscape, Fannie Mae and Freddie Mac have also increased reserve requirements for high-risk loans, introduced treasury floors and limited loan sizes in some cases. “For now, the agencies have decided to no longer offer index locks and simplified forward rate locks, two very important factors in mitigating interest rate risk,” he added. Salyards added.

For acquisition loans or cashless refinancings, Freddie and Fannie still offer up to 80% LTV with partial interest only terms. Financial arrangements require debt service reserves and imply an increased emphasis on collections. “The availability of full leverage in this environment is a testament to why we need the agencies present to meet client needs. I don’t expect this to change in the future ”, said Salyards.

However, stricter requirements for borrowers will likely remain the norm until at least the third quarter. Increasing debt coverage ratio agreements and scrutinizing property cash flows will temporarily limit loan amounts, but that will change once the economy reopens and rent collection improves. . The big unknown, of course, is when the economy returns to full force.

This time next year

Shahin Yazdi, Director, George Smith Partners. Image courtesy of George Smith Partners

While the leverage point has not changed, the means of covering the debt portion of the capital pile have changed. Today, a borrower needs mezzanine financing, senior equity or private sources to reach 80%, “Whereas in a year I see the debt funds become aggressive again and the CLO bridging lenders being able to recover up to 85% of LTC” Yazdi predicted.

In addition, Fannie Mae and Freddie Mac will continue to benefit from full leverage, which will not put any additional structure in place. “In twelve months, the economy will be on a better footing and access to debt will be easily accessible. said Salyards. “By then, other lenders will have returned to the market, such as debt funds and CMBS.”

USAA Real Estate research shows that the global banking system is healthier today than it was during the Great Recession, but loan losses from the current recession could be several times greater than it was during the Great Recession. ‘ten years ago, due to potentially large defaults at several profit centers. The Federal Reserve’s actions may not be enough to provide the necessary liquidity to the financial system, which could lead to insolvency for some banks.

The discipline of borrowers will be essential in the coming quarters and will be at the heart of multi-family financing strategies. Salyards advises borrowers to use the best inputs available to them, as well as realistic assumptions about rents, rent growth and expenses, and to only leverage to the point where an agreement will be able to maintain the cash flow despite most economic shocks.

Another risk for multi-family financing vsould be falling property values. In the worst-case scenario proposed by Trepp, CRE prices could drop as much as 35% over the next two years, a trend that would make refinancing extremely difficult.

Trepp’s current best-case scenario is that the economy will begin to rebound by the fourth quarter of 2020. Salyards says he likes the analogy of a tick-shaped recovery – a steep decline followed by slow growth. and regular. But it also offers a caveat: “The effects of this on the US balance sheet will persist indefinitely. The dollars printed to support people are on a scale we have never seen before. “

Read the June 2020 issue of MHN.

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