Like everyone working in commercial real estate during the last 19-plus months, the financial pros in the commercial lending industry have faced plenty of challenges as the COVID-19 pandemic refuses to fade. But like others in this industry, commercial finance professionals have worked hard to overcome these challenges.
What has the last year-and-a-half-plus been like for the commercial finance industry? Midwest Real Estate News spoke with Jim Doyle, executive vice president in the Cleveland office of Bellwether Enterprise, to find out.
Doyle said that the industry has faced struggles throughout the pandemic. But he also said that it has been surprisingly resilient, too.
“Things feel more like normal today,” Doyle said. “When we were sitting back and staring the pandemic in the face last April, May and even June, there were real concerns about where the commercial real estate market would be. There were worries about whether lenders would be willing to lend. Fortunately, that dissipated quickly.”
Today, Doyle said, the lending market remains robust, led by Freddie Mac and Fannie Mae on the multifamily side. But it’s not just Fannie and Freddie that are active. Doyle said that life insurance companies and bridge lenders, which did drop out of the market during the earliest days of the pandemic, have returned and are now being aggressive with their pricing and terms.
That’s good news. But it doesn’t mean that there aren’t challenge in today’s lending market. One of the biggest? Doyle says that all these lenders are chasing the same types of deals: multifamily and industrial transactions.
That means that financing for other deals can be trickier to find.
“We have never seen on the sales side cap rates being bid down this aggressively both on multifamily and industrial,” Doyle said.
Two booming asset classes
It’s not surprising that industrial and multifamily are attracting the most attention from lenders.
On the industrial side, consumers continue to flock to the Internet to buy everything from electronics and toys to groceries, sporting goods and cleaning supplies. The pandemic has only boosted the rise of online shopping.
And as this trend continues, it’s forcing companies to open new distribution centers and warehouses across the country. The developers building these facilities need money to fund their projects.
“Everyone is delivering products quicker and quicker,” Doyle said. “People want their products delivered overnight. Because of this, the distribution market has taken off. COVID helped fast-forward that. People have been home and they are getting everything delivered to them, from groceries to whatever else they need from Amazon. There has been such incredible growth in the distribution market.”
The multifamily sector has benefitted from outside forces, too. First, renters have largely paid their monthly rents on time throughout the pandemic. That has helped the multifamily sector remain strong throughout the last 19-plus months.
Secondly, the costs of single-family homes continue to rise. This has priced many would-be owners out of the market. Instead of buying a home, then, these people are continuing to rent. This, too, has boosted the strength of the multifamily market.
“There is so much capital in the market on the buy side, and there are few greater alternatives to get returns right now then the multifamily market,” Doyle said. “Multifamily is still in a very good place.”
Doyle said that despite the struggles some commercial sectors face, Bellwether Enterprise is still seeing a wide variety of deals. That includes some office and retail financings.
But lenders working in those asset classes hit harder by COVID are requiring more of borrowers, Doyle said.
“We see lower loan-to-value ratios and more conservative deals from lenders willing to do office and retail today,” Doyle said. “In the hotel space, you are paying a higher price in rate and you will see conservative terms. You will see much more conservative terms from lenders willing to lend and invest in those asset classes.”
The hotel sector is an especially interesting one today. As Doyle said, leisure travelers have largely returned, helping hotels fill more rooms throughout the summer. But many hotels rely on business travelers, and business travel has not yet returned. And there’s little indication that companies will be sending their employees on the road again anytime soon.
“It’s tough to pinpoint when business travel will come back and to what extent,” Doyle said. “Are we going to be on the road as often as we were previously? Or have Zoom calls and Microsoft Teams calls replaced some of that?”
The office sector faces some of the same uncertainty, and that makes lenders a bit more wary when debating whether to finance deals in this space.
As Doyle says, it’s too early to know whether companies will embrace flexible work schedules that allow employees to work from home several days a week. If they do, will these companies need as much office space? And will the owners of office towers and campuses struggle, then, to find tenants?
“Lenders do think it’s again too early to know what the answers to these questions will be,” Doyle said. “Many companies still have several years left on their office leases. We aren’t going to see big changes in office space overnight. But ultimately, will companies shrink their office footprints?”
Despite the challenges, Doyle says, it has been mostly business as usual in the commercial lending business for life insurance companies, banks and CMBS lenders. As Doyle says, lenders are looking and hungry for deals.
But what do companies such as Bellwether look at when considering whether financing deals make sense?
Not surprisingly, COVID-19 is playing a role. Lenders want to know how a particular property performed during the pandemic before they close a financing deal.
“One question that gets asked today is ‘How has the property been affected during COVID, if at all?’” Doyle said.
Lenders who are looking at a multifamily deal will ask if all the apartment building’s renters have been paying their monthly rents on time. If it’s a retail deal, they might ask whether owners had to give concessions to keep tenants in place and if all these tenants are current on their rents. If it’s office, they’ll ask when tenants are bringing employees back.
“These are issues we never had to deal with before,” Doyle said. “But these are questions borrowers will have to know the answers to. Outside of that, it’s still core real estate principals.”
And what does Doyle expect to see in the commercial lending business during the next several months and into 2022? He’s predicting steady business.
Some owners, for instance, are considering selling now because they fear changes are coming to the way capital gains will be taxed. Because of this, they are eager to sell before the end of the year.
But otherwise, Doyle says, lending requests should continue to come in at a steady pace.
“As long as interest rates stay where they are and all other things being equal, real estate should still bring strong returns to investors,” Doyle said. “The returns on real estate should still be better than what investors can get with bonds or stocks. Because of this, real estate attracts a lot of capital. That will continue to drive the market. We are still very active. We don’t see that changing going into early next year.”