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Undeniable COVID-created inertia is driving the commercial real estate market today, with innovative approaches surfacing to consummate transactions.
The fear and anxiety, hope and fulfillment of dreams, and confusion and uncertainty being felt by society as a whole are certainly impacting those invested in the commercial real estate life cycle.
Sellers, buyers, lenders, and borrowers all are experiencing the impact of the worldwide pandemic pause. It’s impossible to escape.
On one hand, sellers fear that the longer their properties are on the market, and as the pandemic and recessionary economy linger, values will decline.
On the other hand, for many sellers who see the glass as half full, they hope and envision values quickly will increase, as the pandemic wanes and the US economy fully reopens.
Buyers want the economy to reopen quickly, yet they hope the stalled economy will give them leverage to negotiate lower pricing on transactions.
Borrowers wish they will be able to secure forbearances from their lenders, but fear that this relief may be short-lived. If the economic impact lingers, even when businesses fully reopen, many tenants – especially retailers selling to consumers – may still be unable to pay rent for several months. This, in turn, will negatively impact a given property’s net income, and ultimately, its short-term resale value.
Fully aware and fearing that time kills deals, lenders, and mortgage brokers are mediating between countervailing forces and the immediate, innate need to keep transactions moving forward.
At the same time, many lenders have put deals on hold, grinding to a halt promising transactions in a not-that-long-ago flourishing landscape. Lenders that have chosen to remain active have been overwhelmed with bottlenecks, as their production pipelines crawl through obstacles created by current market dynamics.
So, where does this leave everyone? Confused for sure, and in many cases, paralyzed by the unexpected and far-reaching nature of current events.
Despite this confusion and paralysis, options abound for the market to move forward.
This is where private debt comes in. Private money lenders offer viable solutions for the commercial real estate market – for borrowers and brokers, lenders, and investors – to get deals done quickly and efficiently.
Private money lending has always thrived during economic downturns.
While the coronavirus pandemic and its widespread economic effects are historically unprecedented, tightening standards and restricted liquidity in the conventional lending space are not new. During cycles when conventional lending opportunities contract, private lending expands, as borrowers and investors alike look for new options.
It’s important to note, however, that private debt is not fully immune to the damage caused by the severe economic impact of COVID-19. In the last couple of months, a number of private debt funds and capital providers either temporarily or permanently shuttered their operations due to a freeze of their capital sources, poor underwriting practices, and/or non-performing loans, resulting from a coronavirus-related forbearance or default.
For those that are fortunate to be actively lending today in the private debt environment, the landscape is riddled with market delays, stemming from rate renegotiations, expanded due diligence, short- term extensions on maturing debt, re-underwriting loans, and arbitraging greater spreads for investors. In addition, since private money – perhaps wrongfully so – tends to be the choice of last resort, there’s the perennial shopping for cheaper debt by traditional lenders.
Despite those unavoidable delays, most purchases and refinances currently in the market require the execution speed that only private lending can deliver— agility that is proving quite beneficial.
For example, we are seeing a significant number of cash-out transactions, as some borrowers seek to inoculate their operating businesses with cash infusions to get them through the current economic hurdle.
Some borrowers are looking at this time to expand their financial coffers in anticipation of ready-made, perhaps even unprecedented, shopping spree opportunities of distressed, but quality, real estate assets.
Other borrowers may be preparing for what they believe could be a slow reopening and reintegration process, or the second wave of reinfection and more closures in the coming fall or winter seasons.
Private lenders are approaching the new market challenges in new and different ways.
Some private lenders are pressing the pause button to focus on managing their existing portfolios and negotiating workouts on any non-performing loans.
Others are actively transacting, but they are implementing modifications to their existing guidelines. Today’s “new normal” in commercial real estate may include all or a combination of the following:
Another group of lenders is choosing to not make any changes. They continue with business as usual mentality, enduring the delays and disruption, and not adjusting for any perceived new market risks.
For mortgage investors, the risk lies squarely within valuation. Without an accurate determination of value, lenders cannot assess how much coverage exists to protect their investments.
The pandemic and its ensuing uncertainty have put that age-old instinct of preservation of capital to the test.
Prudent private lenders aren’t standing by to see what happens. They are adjusting their valuation methodologies and underwriting standards to ensure that there is ample equity coverage to account for the new economic, political, and societal stresses on property values.
These risk-based adjustments include, singularly or in combination:
How long these pandemic-induced changes to underwriting practices and lending guidelines will continue remains to be seen.
Unlike traditional lenders who are hampered by the burdens of federal regulations, private lenders are nimble and can pivot to meet a range of market demands and unique circumstances.
Whether a borrower is seeking speed of execution, a short-term bridge to traditional financing, creative loan terms, or a solution for personal hurdles, such as foreign national status, limited liquidity, bankruptcy, or a low credit score, private money always has served and will continue to meet, specific needs in the market.
During COVID-19 and the ensuing period of economic recovery, private lending for the commercial real estate market will continue to further solidify its position in the capital markets as an irreplaceable, solutions-focused financing strategy.
With the inertia-busting agility of private debt, along with the guidance of experienced, trusted mortgage brokers and advisors, commercial real estate investors and developers can continue to move forward and thrive, even in the midst of a global pandemic.
Source: GlobeSt By Elliot Shirwo | June 16, 2020, at 07:20
About Marcus & Millichap Capital Corp.
Marcus & Millichap Capital Corporation (MMCC) is a leading source of real estate capital nationally. In 2019, the firm sourced and closed $7.8 billion in commercial debt and equity structures through 1,944 capital markets transactions across the U.S.
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GLEN ELLYN, IL, June 16, 2020 – Marcus & Millichap (NYSE: MMI), a leading commercial real estate brokerage firm specializing in investment sales, financing, research, and advisory services, announced today the sale of a 12-unit apartment property located in Glen Ellyn, IL, according to Steven D. Weinstock, regional manager and first vice president of the firm’s Chicago Oak Brook office. The asset sold for $1,060,000.
The buyer, a private investor, was secured and represented by Randolph Taylor, associate, and multifamily investment specialist in Marcus & Millichap’s Chicago Oak Brook office.
The property is located at 30 Briar St in Glen Ellyn, Illinois with easy access to Interstate 355. The property is a well-maintained, fully-occupied, 12 unit multifamily property consisting of all two-bedroom, one-bath units. The property was sold to a repeat buyer for the agent and the firm in an all-cash transaction.
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About Marcus & Millichap (NYSE: MMI)
With over 2,000 investment sales and financing professionals located throughout the United States and Canada, Marcus & Millichap is a leading specialist in commercial real estate investment sales, financing, research, and advisory services. Founded in 1971, the firm closed 9,726 transactions in 2019 with a value of approximately $50 billion. Marcus & Millichap has perfected a powerful system for marketing properties that combines investment specialization, local market expertise, the industry’s most comprehensive research, state-of-the-art technology, and relationships with the largest pool of qualified investors.
Unemployment benefit expansion mitigates financial impact. Many throughout the nation are faced with uncertainty as COVID-19 rattles the economy and labor markets. The federal government has been fast-acting in its response, exhausting numerous fiscal and monetary measures to keep the economy afloat and provide income to those who suddenly face hardships. Unemployment benefits have been both increased and expanded, supporting laid-off workers’ ability to stay up to date on important bills, including rent. The new criteria for unemployment benefits include freelance workers, the self-employed, contractors, and part-time personnel in addition to those who would typically meet specified standards. The federal benefit period lasts until July 31, and those who qualify for unemployment will receive $600 per week on top of a state benefit, which varies throughout the nation and generally aligns with the cost of living. State benefits will also be extended an additional 13 weeks beyond the exhaustion of the prototypical benefit period. This action will be wide-reaching and relieve some of the stress that hangs over both tenants and owners of multifamily. Although, the process of distributing payments will likely be delayed as unemployment offices are being overwhelmed with requests.
Government payment provides renters with an income stream to offset financial burdens. The other vital aspect of the stimulus package is the one-time payment to all adult Americans that filed taxes in 2018. Most adults will receive $1,200 in addition to $500 per child under the age of 17, with installments phasing out for individuals that made over $75,000 and dropping off completely above the $99,000 threshold. The federal government has indicated that direct deposit payments will arrive by the end of April; however, those who will be receiving checks in the mail might not get them for at least a couple of months. The additional income should make up for some wage losses and supplement income streams for those who have not been negatively impacted. Based on early reports, 69 percent of renters were able to meet April rent obligations by the fifth of the month, down 13 percent year-over-year despite unparalleled circumstances.
Apartment fundamentals on solid footing entering this year. Multifamily housing performed exceptionally well over the course of this cycle, driven by the affordability of renting an apartment relative to owning a single-family house, and the younger generations’ preference for leases and added amenities. Over the past few years, workforce rentals became increasingly undersupplied, as vacancy was near 20-year lows ending 2019. Among the three segments, Class C vacancy contracted by the greatest margin since 2009’s peak, dropping 570 basis points into the mid-3 percent range. Class B vacancy followed closely behind, dropping 330 basis points since the Great Recession peak into the low-4 percent area as of the beginning of this year. Tightening conditions have supported the need for rapid inventory growth; however, rising construction costs have led builders to construct more Class A units, which has not provided much relief for the budget-friendly rental segment. Despite the elevated construction of luxury apartments over the past decade, Class A vacancy has also dipped 230 basis points since 2009 into the 5 percent range, demonstrating robust demand throughout all echelons of multifamily housing.
Some markets and niches are better prepared to weather the storm. The risk level that the apartment industry will face differs throughout the country, as some markets and population segments will have to combat more pronounced headwinds. Lower-tier space may be burdened by the fact that their tenant base is more likely to be affected by job losses and financial hardship, whereas midtier space might be better suited to maintain cash flow. Additionally, upper-tier space has a stronger ability to avoid losses from missed rental payments as more tenants are able to work from home and have savings built up; however, newly built luxury apartments will find it difficult to build a tenant roster over the short term. Working-class rentals in some of the nation’s more expensive cities will face obstacles as government payments don’t go as far as to cover monthly rental costs. On the other hand, metros with diverse economies will be less at risk as several sectors of the U.S. economy are still functioning, including technology, industrial and construction.
Multifamily owners will have to overcome hurdles. In the short term, finances will have to be closely watched and managed, as a reduction in rental income is entirely possible, while expenses may arise concurrently. The extra costs to maintain clean common areas through increased labor and sanitation, as well as the likelihood of more maintenance expenses linked to wear and tear as residents spend more time than usual in their apartments will be hurdles. Additionally, owners of newly built apartments will find it more difficult to fill units, as fewer people are moving around and actively searching for residences. A longer-term headwind could be the slowdown of household creation amid more people moving back in with their families or seeking roommates due to financial burdens. These challenges will dissolve once the economy is returned to full functionality and the health crisis is over, but with no clear timetable, it is important for owners to be cognizant of the obstacles they will face.
• Large tourism-based economies are facing more direct impacts that will weigh on their labor force. These headwinds may linger until the population feels safe traveling again.
• Rentals in markets at the height of their COVID-19 outbreaks are more at risk from strict shelter-in-place orders. State and local government reaction will be vital to regaining economic momentum.
• Regional logistics hubs in the Midwest and the central U.S. may be more stable, as e-commerce will act as a tailwind in maintaining the job market. Although, international supply-chain disruptions may have an adverse impact on some coastal markets.
Federal agencies and local governments putting moratoriums on evictions. The CARES Act initiated a 120-day eviction moratorium that disallows borrowers of federally backed mortgages or who participate in federal assistance programs from beginning eviction proceedings for nonpayment, started on March 27. These same landlords must also give tenants a 30-day notice to vacate the property after the eviction moratorium period has passed as well as conform to local eviction laws. Landlords that fit into these classifications and have fewer than five units fall under the homeowner protections included in the CARES Act, which disallow evictions for 60 days started on March 18. Properties without federally backed mortgages or that do not participate in federal assistance programs would default to the state provisions. More than half of the state governments have enforced a pause on evictions, typically lasting between 30 and 60 days. Additionally, local governments, particularly in some of the nation’s most densely populated cities, have followed suit in halting evictions through at least the end of April. Owners that are not disallowed from evicting tenants should take into consideration that it may be more challenging to fill vacant units given the current conditions.
• Halt evictions for 90 days for those who can show they have been financially impacted by the COVID-19 pandemic. (Does not apply to evictions for other lease violations such as property damage, criminal activity or endangering the safety of other residents and staff .)
• Avoid rent increases for 90 days to help residents weather the crisis. Create payment plans for residents who are unable to pay their rent and waive late fees for those residents.
• Identify governmental and community resources to help residents secure food, financial assistance, and healthcare and share that information with residents.
Borrowers of federally backed mortgages granted relief. The Coronavirus Aid, Relief, and Economic Security Act includes protections for those with multifamily mortgages backed through federal agencies, including Freddie Mac and Fannie Mae. Borrowers of these agencies may request loan forbearance, given that they were on time with payments through February 1 and can provide proof of financial hardship from the new coronavirus. The period of forbearance is initially set at 30 days, with two additional extensions available for borrowers that request it within the time frame specified in the agreement. This may be a resource that provides owners an opportunity to cushion themselves, while being aware that it includes stipulations for owners, including bans on evictions and disallowing late payment fees. Additionally, those who seek forbearance will be required to repay within 12 months. Borrowers with mortgages through private lenders should communicate with their providers to discuss options that are available to help them through this challenging time.
The apartment industry is adapting to combat headwinds. During times of uncertainty, owners may find it necessary and beneficial to be more hands-on with their investments. Open communication with tenants regarding their financial status could formulate realistic expectations for rental income so that owners can anticipate any losses and put plans in place to maintain cash flow. Additionally, owners facing financial uncertainty should reach out to lenders to discuss loan forbearance options and talk to property managers about logistics and operational procedures. Every owner will face their own unique challenges, and the ability to adapt while in the unchartered territory of a global pandemic will be favorable in prospering through these headwinds. Some may even find this is an opportunity to retain quality tenants through new leases, as they are less likely to explore other options during the crisis. Investors looking to buy and sell will have to discover new pricing as the eminent downturn will alter asset values and underwriting standards.
Multifamily remains a solid commercial real estate investment through periods of uncertainty. The $2.2 trillion stimulus bill provides a safety net for the short term while the population works together to slow the spread and medical researchers race to find a vaccine that can bring a sense of normalcy back to daily life. Multifamily owners are concerned with the financial impact that will come of this, but several factors support an optimistic viewpoint. Government payments and unemployment benefits will help renters replace lost income over the near term, enabling them to pay on time. The underlying trends that have supported apartments throughout this cycle continue to be in place and will sustain robust demand for rentals in the long term. One of the fundamental principles driving multifamily housing is that people will always need a place to live. The global pandemic will not push prospective renters toward single-family housing as an alternative as the rent to home payment gap remains significant.
National Multi-Housing Group
John Sebree First Vice President, National Director | National Multi-Housing Group
Prepared and edited by
Ben Kunde Research Associate | Research Services
The information contained in this report was obtained from sources deemed to be reliable. Every effort was made to obtain accurate and complete information; however, no representation, warranty or guaranty, express or implied, may be made as to the accuracy or reliability of the information contained herein. This is not intended to be a forecast of future events and this is not a guaranty regarding a future event. This is not intended to provide specific investment advice and should not be considered as investment advice. Sources: Marcus & Millichap Research Services; Bureau of Labor Statistics; CoStar Group, Inc.; Experian; Federal Reserve; Global Financial Data; MBA; Moody’s Analytics; NYSE; Real Capital Analytics; RealPage, Inc.; Standard & Poor’s; TWR/Dodge Pipeline; U.S. Census Bureau; Yardi © Marcus & Millichap 2020
John Chang – Director Research Marcus & Millichap