By Terry Painter/Mortgage Banker June 3, 2020
Author: The Encyclopedia of Commercial Real Estate Advice (A Willey Book)
Release Date: September 2020.
[UPDATED: June 3, 2020]
To our valued borrowers: Apartment Loan Store remains a reliable source of capital during this challenging economic time. As we enter a global recession due to the corona virus, we are still providing lower rate multifamily financing nationwide for those in need. As a mortgage-banking firm, we can remain agile in our ability to utilize funds from FHA, Fannie Mae, Freddie Mac, and our strong regional banking presence. We can still do cash out refinances up to 75% LTV for Multifamily Properties. This goes up to 80% with FHA funding.
How Commercial Property Types have been Affected
The COVID-19 economic crisis has continued to create havoc for commercial real estate lending. Hotels and office properties have gotten hit the worst, with unanchored shopping centers close behind. Multifamily properties have held ground with 91% of renters nationally paying the rent in May according to the National Multifamily Housing Council. Most of the rent collection problems have come from C class apartment buildings in working class neighborhoods. Lifestyle A and B Class multifamily have had about 98% of tenants paying rent. This is likely because more of these renters can work at home, have retirement income, or have savings. Industrial properties have also held up well. Commercial properties that have necessity based tenants like grocery stores, drug stores, and investment grade tenants such as Walmart, Whole Foods, Walgreens and UPS are doing great. As we enter into June, underwriting guidelines for most commercial mortgages continue to tighten, with the exception of government backed loan programs.
How Commercial Appraisal Values are being Affected.
With unemployment claims going over 40 million at the end of May, are we in a depression instead of a recession? It is still too early to tell. Many commercial lenders and appraisers are now faced with finding a sensible way to lower property values based on lower economic occupancy (occupancy from rents collected). When you think about it, a commercial investment property is a business, and lenders and appraisers expect it to be valued based on actual income received. And there are not unpresented rental delinquencies. They are rampant and expected to be worse in the coming months. At this time Banks and their appraisers are raising market vacancy and are lowering gross rental income on top of this to compensate for collection losses. This is resulting in a drop of property values of close to 7%. Keep in mind, that prior to this economic crisis, property values had been consistently increasing for 10 years resulting in overly inflated values.
Government backed loan programs from Fannie Mae and Freddie Mac have a more liberal approach right now and are not raising vacancy or lowering gross rental income due to collection losses. They are using comparables from the last year for both the sales comparable and income approaches. This is resulting in appraised values that are not noticeably down at this time.
Fannie, Freddie and HUD Lower Interest Rates
In Mid-March 2020, Government backed loan programs for multifamily – Fannie Mae and Freddie Mac raised rates on a ten year fixed mortgage from an average of 3.45% to 4.85%. HUD/FHA rates followed suit. While the 10-year treasury was trading at 0.80%, Fannie instigated a treasury yield floor of 1.10% effectively raising rates by 0.30%. These loans are converted to mortgage backed security bonds which are sold to investors on Wall Street. The problem was that although all these mortgages are guaranteed, no one was buying them. Interest rates went up because the bond trading desks had to increase the earnings on them drastically to try and get investors more interested. This caused rates on these mortgages to skyrocket.
On March 26, 2020, the Feds announced that they would be purchasing 200 Billion Dollars of mortgage backed security bonds over the next two months. The next day when they made their first purchase, the rates on Fannie Mae, Freddie Mac, and HUD/FHA dropped considerably. During the week of April 13th, rates have dropped on these programs very close to where they were just before the virus crisis. Last week rates on these programs dropped by an average of .25%. The stimulus money should be appropriated through the fall and many months beyond if needed. If you have a balloon due soon on your multifamily property, it would be prudent to apply for refinancing your property now. Rates on these programs are still very low.
Commercial Interest Rates at Banks
When the COVID-19 crisis hit, smaller community banks and large banks were in very good financial condition. Banks determine their long-term commercial interest rates based on their cost of funds. This includes the interest they pay their depositors, the cost of employment, rent, taxes, insurance and utilities. This often averages around 1.75%. Anything above this is profit to be shared with shareholders. Assuming a profit of 1.75%, this would put their interest rate floor at 3.50%. But we do not see bank rates that low today. Where most floors were at around 4.00% prior to the virus crisis for a 5 year fixed commercial mortgage, these have been raised to 4.50%. Some banks have pushed rates up to 5.00% on high leveraged loans to hedge against the uncertainty of the borrower weathering this storm.
Today many banks are not making commercial loans as many do not pencil, and their staff is overbooked on loan modifications. The majority of banks that are making business and real estate investment property loans are not doing cash out right now. Many banks are making loans on lower risk multifamily properties and only lending at 65% LTV or lower. Most banks are requiring a 6 – 12 month payment reserve to guarantee that payments will be made in the future.
Underwriting Guidelines are Tightening
A recession causes property values to drop. Banks are especially concerned that if they make a loan at 75% LTV today, the loan will be at 80% LTV in six months if the property goes down in value. As mentioned, for multifamily loans, many banks are raising vacancy to 10% and then taking another 10% off from gross rental income for collection loss. They are then stressing the underwriting interest rate by raising it as much as 2.00%. On top of this they are raising their DSCR from 1.20 to 1.25 or from 1.25 to 1.30. The affect of this is obviously lowering loan amounts. Some banks are also requiring a 6 month payment reserve at closing to be held for a year to ensure that loan payments are made.
Freddie Mac has tightened by lending a maximum of 75% instead of 80% with cash out. For mixed use buildings, commercial space will be underwritten as vacant. Life Companies and most Commercial Mortgage Backed Security (CMBS) lenders are not lending right now. Fannie Mae, Freddie Mac and HUD/FHA, are now requiring from 6 – 18 months mortgage payment reserves to be deposited with the lender at closing as insurance that future mortgage payments will be made. After a year if the properties are meeting their minimum debt service coverage ratio (DSCR), these funds are returned. But for now these government securitized loan programs are not raising vacancy or collection
Commercial Construction Loans
Construction loans are always considered a higher risk for lenders. When a recession begins, many lenders eliminate them all together which is happening now. This is because they really don’t know what the need will be for the property or what rents will be like when it is completed and filled with tenants an average of 18 months later. If you are in need of a larger construction loan for a multifamily property call us about HUD construction financing. We are specialists with this loan product since 1999. HUD will still be lending at 85% Loan to Cost with great non-recourse construction loan rates that roll over to a 40-year fixed fully amortizing non-recourse permanent loan.
Multifamily/Apartment Loan Rates often change daily. Many Regional Bank Loan Programs allow you to lock the rate at application. Government Agency programs like HUD/FHA, Fannie Mae and Freddie Mac have the lowest rates and fix rates for the longest duration from 10 - 35 years and can lend up to 85% LTV. Their rates are usually locked at loan approval. As with all commercial loans most lenders determine their cost of funds based on an index. They then add a spread to this index. An example of an index would be the 10 year treasury yield. Lets say this is at 2.75%. If the spread is at 2.00% the rate will be 4.75%. Most of our apartment loan rates are determined by taking the current 3- to 30-year treasury yield plus a spread of 1.50% to 2.60%. With the exception of HUD/FHA which has the lowest long term fixed rates, the longer you fix the rate, the higher the rate.