How Lenders Are Reacting to the Quarantined Market

Chris Peters
April 23, 2020

Over the course of the last few months, the entire world has been rocked by COVID-19. When specifically thinking about commercial real estate, we’ve seen hotel bookings basically drop to zero, limited foot traffic in most retail stores, companies instructing their employees to work from home while their offices remain bare, and families struggling to pay their mortgage or rent because of lost wages. This virus seems to have affected every aspect of commercial real estate, and lenders have taken note. StackSource recently conducted a wide outreach to our platform of hundreds of banks, credit unions, debt funds, and other lenders to gather feedback on, you guessed it, what’s changed. Below are some findings.

Lenders' primary response to the market volatility has been to reduce LTV. For stabilized properties, this has meant reducing the typical 70–80% max LTV to somewhere in the 60–70% range, depending on the lender, asset type, location, and other factors. Some lenders that are more conservative by nature that tend to be in the 65–75% range have reduced even further to 50–65%. By reducing LTV, the borrower has less debt to service (which is a blessing if NOI starts to slip because of lost rental income) and the lender has a reduced basis in the property should they need to take over. The lower LTV protects both sides, but requires the borrower come to the deal with more equity.

Secondly, lenders have scaled back lending on certain asset types. Because of the mandated isolation and social distancing, hospitality and retail seem to have been hit especially hard. People are no longer traveling for work or pleasure and consumers have been limited to goods and services offered online or delivered to their front door. Restaurants, barbershops, salons, clothing stores, fitness centers and the like have all been forced shut.

Thirdly, when underwriting a new deal, lenders may discount rental income by increasing underwritten vacancy to account for the potential loss of rental income. If a property is 100% occupied and the normal vacancy rates are 3–5% in the area, the lender may model vacancy at 10%. This extra cushion in vacancy provides the lender with increased confidence the debt can be serviced even if the property’s vacancy (or rent forbearance) increases.

Moreover, when it comes to borrower liquidity, there is no real industry standard.  Some lenders have internal requirements and others, especially agency lenders like Fannie Mae and Freddie Mac, have hard minimums such as having 9 months of debt service payments liquid after close.  Another way lenders have been reducing risk in the current environment is by requiring borrowers to have more cash in the bank.  A few lenders we spoke with are looking for 12-18 months of PITI (principal, interest, taxes and insurance) liquid at closing.  This may seem excessive, but it's just another way to ensure a property (and it's owner) will cover debt service. Many lenders are paying more attention to the liquidity of loan guarantors now.

Lastly, with respect to refinances, some lenders are scaling back on the amount of cash out they are giving borrowers. Some lenders are not providing any cash out at this time, while other lenders that typically will provide cash out up to 75% LTV are limiting the refinance LTV to a more conservative 60–70%. Lenders don’t want to take a chance of having a high basis in the property at such a volatile time.

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