The near-term financing outlook? High demand, a need for speed and signs of life in even the most challenged of sectors
The commercial real estate market has displayed true resiliency throughout the COVID-19 pandemic. And that means that the commercial financing market? It’s done the same.
Just ask the professionals working in this field. They’ll point to steady activity as financing requests continue to soar, especially for such in-demand sectors such as multifamily and industrial. And the best news? These same professionals are even seeing a small uptick in the demand for office and retail deals.
This trend doesn’t look to slow anytime soon, either. Financing professionals working in the Midwest said that they expect demand for commercial loans should only increase throughout 2022.
Normal is back … mostly
Jim Doyle, executive vice president in the Cleveland office of Bellwether Enterprise, said that he is seeing the signs of a return to normalcy in the financing market.
But this isn’t necessarily new. Doyle said that requests for commercial financing have been strong for more than a year now.
“Last year was similar to what we are seeing now in the sense that there hasn’t been much of a change in the financing world,” Doyle said. “We have been busy, and we haven’t seen that change going into 2022.”
The challenge? Most lenders are chasing the same product types, multifamily and industrial. Self-storage facilities are popular, too.
Charles Krisfalusi, director in the Detroit office of Walker & Dunlop, knows just how strong the multifamily market is today. That’s because he specializes in originating multifamily loans.
He’s seen, then, demand for multifamily financing steadily rise, even during the pandemic.
But that doesn’t mean that this sector doesn’t face challenges, Krisfalusi said.
“Right now we are at a crossroads,” he said. “There is a ton of activity on the investment sales side. People are looking to buy. There is very little yield in the market, so multifamily is a strong performer. There is a lot of capital looking for a home in multifamily. But there is also volatility in the Treasury market. The next day, you’re either value-constrained or interest-rate constrained. The good news is that this is not yet dampening activity.”
Krisfalusi said that the key for commercial lenders in today’s busy market is speed. Clients want deals to close quickly, before interest rates rise any higher.
“We have been differentiating ourselves with early rate locks and streamlined rate locks,” he said. “Anything we can do to eliminate uncertainty will help people who know when they want to execute. The difference-maker lately has been speed.”
In the multifamily sector acquisition financing is hot, Krisfalusi said. And many borrowers in this space today want the HUD 223(f) loan.
Borrowers can use this loan to refinance newly constructed properties and take cash out while doing it.
“It is the best tool we have now in our chest,” Krisfalusi said. “We focus on this product when we have anything under construction or in stabilization or recently stablized and less than three years old. This is a product that adds stabilization and that cashes out beyond construction costs. Demand for that product has been increasing in the last several months.”
Not all asset types are created equal today
The more challenging asset classes for financing? Doyle points to office, retail and hotels.
But there are positive signs even in these asset classes that were hit particularly hard by the COVID-19 pandemic.
“We are seeing the ability to get office and retail deals done again,” Doyle said. “Those sectors are a little more active now. We have closed more retail deals in the beginning of this year than we did all of last year. There has been a little more receptiveness from lenders to finance those.”
Doyle said that lenders are still concerned about office deals. They still have questions about the overall office market, too. Will law firms downsize because some of their senior partners are working from home? Will the new flexibility in workspaces, with more employees certain to be spending more time working remotely, impact the amount of office space companies need?
“There has to be a story behind an office deal if it is going to get done,” Doyle said. “Are companies shrinking? Do they still need as much office space? What will the office market look like five years from now? Unfortunately, none of us know the answers to those questions yet. Because of that, lenders are more conservative when it comes to underwriting and looking at office deals. There is a push to lower loan-to-values.”
As far as retail goes? Doyle said that lenders are focused on grocery-anchored retail centers or centers that feature big-name home-improvement stores such as Home Depot or Lowe’s. Centers anchored by major retailers such as Target are viewed as lower risk by lenders, too.
Doyle said that smaller strip centers anchored by known performers such as Chipotle, Panera, AT&T and Verizon-type users are also seen as financeable today by lenders.
“Where we do get some pushback is from the junior-anchor spaces,” Doyle said. “Lenders like TJ Maxx and Ross Dress for Less. But there is still uncertainty around Staples and other office stores and places like pet stores. How much space will they need going forward? Who will fill those junior-anchor spaces if those retailers aren’t there?”
While multifamily has held steady throughout the pandemic, Krisfalusi said that not all apartment properties are performing equally well.
In the Detroit market, for example, apartment developments in suburban locations tend to see lower vacancies and rents that are rising faster, Krisfalusi said.
“There hasn’t been as strong a return yet to the urban core,” Krisfalusi said. “The rents are going up in that outer circle of suburbs. That is where we are seeing new construction happening, too.”
Krisfalusi says that he expects apartment rents to continue to rise in most markets throughout the rest of this year. They probably won’t rise at the same rate as they increased last year, though, when monthly rents rose at an historic pace.
“Consumers are absorbing price increases everywhere,” Krisfalusi said. “Rent is just one more of those areas.”
What are lenders looking for?
Lenders today are focused heavily on the rents and sales that retail centers are logging per square foot, Doyle said. They also want to ensure that these centers’ occupancy costs are in line. Doyle said there is more of a focus from lenders on the quality of the tenants at retail centers.
And when looking at loan-to-value? Doyle said that in the past lenders would be able to get up to 75% LTV on retail financing deals. Today, that figure is capped by most lenders at 65% LTV, he said.
“There has to be a little more selling today from sponsors to make lenders comfortable,” Doyle said. “We need a good sense of the strength of the center. There is more data out there today. We have data that can tell us if we are looking at a top-10 store in the market. Lenders are digging in and trying to understand the story behind a deal and trying to learn how strong a center might be.”
Krisfalusi said that while COVID cases have been falling — at least as of the writing of this story — the multifamily market is still not completely out of the woods when it comes to the renters’ assistance programs that states and municipalities launched during the pandemic.
When considering financing requests, then, Walker & Dunlop looks at the accounts receivables and collections of sponsors. Lenders want to be certain that there haven’t been any spikes in the prior 30 to 60 days of tenants entering economic assistance programs or renters not making payments.
“There is still a focus on good accounts receivable to make sure we are not catching a spike when closing,” Krisfalusi said.
But despite this added caution, Doyle said, there is also more optimism today on the part of lenders. There is a feeling that the United States has already made it through the worst of the COVID-19 pandemic.
“When looking back at April of 2020, we were all fearful of bad outcomes in retail and in multifamily, too,” Doyle said. “I have been surprised at the resiliency of commercial real estate. We’ve looked at 10 to 15 shopping center deals already this year. All the centers were paying full rent. Any kind of COVID concessions have been fully paid back. We saw that multifamily tenants for the most part did not stop paying their rents. We are now starting to see a rebound in most sectors. The future looks promising.”
Krisfalusi agreed with this sentiment. He said that tenants historically have paid their monthly rents even during challenging economic times. Why? Everyone needs a home, and consumers prioritize housing when they face financial struggles.
“People historically have paid their rents and mortgages,” he said. “And during COVID? People’s homes became their offices, their cocoons. People did everything they could to pay their rents to keep their cocoons.”
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