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Commercial loans are what brings your real estate deals to life, and given that the Coronavirus has affected lending significantly, we are keeping a pulse on what is going on, and what the potential impacts will be in the real estate prices. Some topics we are curious about are how should borrowers prepare for lending as we start to come out of this? What will likely happen in the lending industry over the next 6+ months, and how should loan contracts look like moving forward?

We are interviewing Billy Brown, he has been in the mortgage lending industry for a few years, and focuses on working with real estate investors. He is a commercial investor himself, which is a very important quality for a lender to have.

Has much changed in the lending industry over the last two weeks?
It was very interesting looking at the historical once the shutdown happened and the virus came out. It was very predictable. But at the same time, when you’re in the midst of it, you don’t know which way to turn. Looking back, it’s very unpredictable. Like the 12 stages of grief, you get the shock factor and then you’re trying to scramble to do everything you can to protect loans and then that’s the unknown, and now the known is that nothing is really going on. We know something’s going to happen in the future with lending, we just don’t know what that’s going to look like. We know that something is going to happen as far as the fallout from people not working. We just don’t know the extent of that. And we don’t know the extent of how much the government is going to come in and solidify that. So, have things changed? Not necessarily, but it has changed. I’ll give you my perspective on this.

Agency debt: if you haven’t talked to your agency debt lender, do. Right now they are up and running, but expect delays in that, especially if you’re putting contracts or offers in properties right now. Expect at least a 90 day close. And you’re going to need escrow for 12 to 18 months of payments and reserves at closing. So your raise is going to be much higher. They’re going to scrutinize properties left and right, as far as your rent rolls and payments and all of that are getting scrutinized, with good reason.

Bank lenders or depository lenders: right now they are scrambling. They were already low on deposits. And they’re going to get lower. So lending for them is going to be tighter for a couple reasons. One is the fact that you’ve the SBA program which is running through the depository lenders that they’re going to have to facilitate. People don’t understand what’s going on with that process so they don’t know how to even answer questions. The other part of it is the forbearance from the existing loans. You have people that are normally doing the loan origination, the business development folks are now back to not taking calls about origination, but they’re actually back to helping on the administrative side, and the operation side to go facilitate those forbearance requests, and sometimes SBA requests. Right now, not much is going on there, expect that to continue for the next couple of weeks.

Non bank lenders, lenders that actually do the more unique things, Non-QM lenders, hedge fund type of lending where they create loans, balance sheet them, and then sell off the notes to Wall Street. Wall Street doesn’t buy anything right now. Unless the lender has a very, very strong balance sheet, which is only two or three lenders that I know of, they’re not originating any more loans until they get some pricing guidance from Wall Street. We do expect, probably in the next seven days, that there is going to be some pricing guidance, and that’s going to open up a lot more lending for folks.

That being said, you still have the reality of all the third party folks that are needing to do the work. Everybody is in lock down. And if you have a kid, you’re trying to get their schooling done, and trying to work on lending, it’s probably not happening. You’re probably at 20% of your performance, maybe 10. I know that’s what I am, trying to juggle everything. Now you’re talking about your appraisers, your title companies, everything on down the list is getting delayed. And then a lot of these lenders, especially Fannie Mae are going to send out the managers to go out and inspect the property. If you’re not allowed to travel or travel is limited, it’s going to be very difficult to go inspect that property for a closing. Expect further delays until we get things back up. But it does appear that talks are in the works, the President is going to start opening up business. I just don’t know what that looks like. Is it by region, is by city, is it by industry, no one really knows but he said that he wants to get businesses open again as soon as possible, and as soon as it’s safe. We will see.

The biggest fallout is what lenders are focusing on, their underwriting has not changed. But just tell me one industry that has not been affected by this negatively. Can you guarantee me that if I do a loan for somebody, they’re still going to be in business in three months? You really can’t. And that’s not for the lenders, but also the people you don’t want to make the situation worse by getting them in a larger debt and hanging something around their neck. That’s going to be even worse. Just take that with a grain of salt. The first thing has to happen is businesses have to reopen. Now what business is left? These are some some questions that you have to ask yourself, and just watch out for. As those dominoes start to fall into place you’re going to start seeing more clarity in the marketplace and lending starting to solidify.

How should borrowers prepare for lending as we start to come out of this?
It really depends on where you’re at in the process, if you’re in the middle of a purchase, or even a refinance that you’re trying to close the next 30 days. You have to ask yourself a lot of serious questions around your third party risk. Are your tenants going to be able to pay? If they can’t pay, do you have enough reserves to be able to withstand 6, 12, 18 months of lower income. We’ve seen some lenders on good properties, on a refinance, say that they’re going to refinance more properties worth this, we do believe is going to be a shorter recovery. But what we’re going to do is just protect you and us we’re going to ask for payments, we’re going to cash you out, but we’re going to ask for payments to make sure that we’re paid, that you’re paid, as well as CapX and all that. They’re not going to release funds for you to go pay off credit cards, or go buy another property.

If you’re in the middle of a purchase, the lender is your friend. Find out what information do we need to have to make sure that the asset I’m buying is still going to be a good asset after this is done.

If you’re not a buyer right now, and think that some sales will be going on. I hope that doesn’t happen because it will be 2008 all over again and that will be really, really bad for the economy. But let’s just say it is, what do you need to do to get prepared? The first thing is let’s get your finances in order. Get your loan package already prepared. Organize all your documents, your taxes, W-2’s, 1099’s, pay stubs, bank statements, PFS, all of that into one place where it’s easy to access. All your rent rolls, everything about your business is organized. You have time now, you might as well get organized. Update your PFS quarterly, we like to do ours monthly, and then you really want to sit back and observe what asset class were you in? What asset class do you think is going to take off? What asset class do you know is going to be demolished through all this? I don’t know, I don’t have a crystal ball. But each little market has its own winners and losers based off of what just happened. Hopefully we’re all winners. That’s my hope. I hope it goes back to normal very quickly. But there are going to be some losers and there are going to be some winners. Getting lending going forward, you’re going to need to have reserves.

How much reserves?
It’s usually a percentage of the loan amount, 12 months is probably what they’re going for. Your loan to values are going to go down, they may go 65-70% loan to value assuming a valuation hit in the fall. Debt service coverage ratios are going to go up probably to 1.3, 1.35. You’ll have to be looking for some solid deals, and let’s say you find something like that, well, who’s the tenant? Who’s the person paying that asset? How’s that going to work? And how are they financially? It doesn’t matter how long is the lease that they sign, if they have a force majeure in their lease and something happens again, let’s say it breaks out again in the fall. And they tell you that they’re done. They’re not going to commit to this five year lease, they’re going to pull up the force majeure card and say that they can’t do this. “We’re breaking these because of that.” What do your contracts look like? What do your leases look like? Talk to your attorney, how do you protect yourself against tenants pulling that card on me, but also, from your lender standpoint, what does that look like as far as lending notes? Get with your attorneys and ask those questions. How do you protect yourself and how long can you protect yourself?

What do you personally think, not wish or hope, will happen in the next six months and later in the lending industry?
Here is my prognostication. Businesses that were on the verge and already teetering, and maybe over leveraged real estate investors, they’re done. They’re not going to get back out. You can see some opportunities there to sweep in and help them by either buying assets from them, or assuming loans, or notes, or all that. The same thing in the multifamily space, I’m not going to give a number, but just to give a number, 10-15% of the assets out there under management are going to go back to lenders, just because they can’t come out from under the the covenants that they signed. I see that as an opportunity. I think that Self Storage is going to be strong. I see real estate itself is going to be strong. I see hospitality and travel, going through the roof, positively, as soon as we get released. You can’t sit here and say, I’m not going to go travel if this thing’s done. We all are. Everybody is itching to get out. I think evening spaces and event spaces are going to be booked up again.

As far as businesses, I don’t know, it depends on the industry. They’re going to look strong, long and hard about their essential employees. And they’re going to look long and hard about their employment contracts. But real estate in general, real estate is always the leader of the recovery. Always is. People are still going to need housing. They’re going to need quality of housing, but in order to leverage you are going to have really solid assets. You can’t go for fringe stuff anymore and speculate, and buy it on pro forma. You really have to buy it off of how is it performing right now? And because of that, I think we’re going to see some normalization of the prices. You’re not going to see these 4.5-5 Cap rates off of pro forma anymore. You’re going to see maybe 5-6 caps off of actuals. This means bigger assets. But nothing off of pro forma. Not now.

Each asset class has its own underwriting and lending. Lending always comes back to common sense from protecting the borrower because the lender is the partner with you on the deal. They don’t get to participate on the upside. They get the guaranteed return. One of my questions to my lender, especially SBA lenders, is we get to December and I need to refinance and they pull my credit. We applied for forbearance. How is an underwriter going to look at that? We get to a year from now, and I have a trailing 12 on my properties, and they see from March to June, it just tanked and I was bleeding out the ears. How’s that going to be underwritten? And now I have that last 12 months, I’m trying to refinance, or trying to buy something else. March, April, May June are down, and I’ve additional debt.

What does that look like? Those are all questions. We just don’t know what the answer is going to be. I have faith in humanity and lending, that they’re going to be able to humanize this a little bit more. I think there’s a positive that is going to come out of this where there’s going to be some humanization and some common sense. Like, everybody took a bath. This is even worse than 2008. Everybody’s taking a bath in this. I don’t know if you could throw those three ones out. I don’t know if you’re going to average that out. I don’t know what they’re going to do. My faith is that their people are going to be able to adjust for that, as a one time occurrence.

Looking into the future. As we come out of this, another pandemic is likely to happen according to what we are seeing out there. What should borrowers make sure that they add to their lending contract in terms of force majeure clause, and feel free to elaborate on what that is for some listeners that may not know what that is. Should they make sure that they have that in the contracts moving forward? Is that negotiable? Can you elaborate a little bit there?
You can always negotiate that in, somebody somewhere is going to come up with a pretty good solution for that. But if I’m looking at things, I want to make sure that it spells are clearly around the next pandemic. Force majeure is great, but I actually want to spell that out even more. So there’s absolutely no ambiguity. In addition to that, there should be another clause in there as far as a government shutdown, I don’t owe you anything, etc. But also the same thing on your tenants, who’s paying for your properties, your assets, your notes, your leases and all that. You have to be human about it, but you can’t be unrealistic. I talked to a guy today that has some big box retailers that are negotiating with him. He has another big box, one you would know, and they’re just being jerks. They said, Hey, we’re not going to pay for three months. If you don’t like it just sue us. As they say, crisis reveals character.

You put people in crisis situations, and characters are revealed. You put me in a crisis situation, I’m fighting, I’m not going to go down, without swinging it. But when you get these tenants, you have to make sure that your leases are spelled out, and that they protect you. But also, again, no one has ever seen this before, in our lifetime. The only thing that comes close is World War II. But you could see that coming. You saw it coming for 20 years. The coronavirus was out of the blue. So how do you protect yourself against that? I really don’t know because a lease is only good as long as someone pays it. I’ve a strong lease on my office complex, with a multi billion dollar accounting firm. But they can say go pound sand. It will be me versus them. You’re going to spend more on attorneys fees than you’re going to get in rent. Those are great questions, and maybe your listeners can chime in and give us their thoughts. I think there are going to be very good ideas. You just have to be awake and watch. I always go back to that homeostasis. Everything goes back to the level. It always does. That’s part of the living process.

Humanity overcomes crisis after crisis after crisis. And you just see that people solve problems. We have that ability to go do it. We can all come together on this thing, we’re going to be able to to do the right things. Globally, the economy was a little soft and teetering a little bit. I think this actually forces us to have a more solid foundation. And with the entire world leaders on this, as well as us individually talking about this. We’re going to be able to solve it. We’re going to come back, and create a very solid foundation for our own personal economy, but also the United States economy and across the globe.

Billy Brown
www.billybrown.me

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