In recent weeks, the ability of commercial real estate owners to access debt and equity has come into question as the novel coronavirus wreaks havoc on the economy. While some deals in the pipeline are still getting done, the debt markets took a pause as the pandemic took hold. Debt markets were waiting for clarity on how various sectors would react, according to Mark Strauss, managing director of capital markets, and Rob Quarton, director of capital markets, with Walker & Dunlop’s Irvine, Calif., office. The two recently spoke with REBusinessOnline via Zoom about the robustness of certain asset types, market stability, debt pricing and adoption of tech-heavy creativity in the wake of COVID-19 and its effects on commercial real estate nationwide.
Commercial Real Estate Debt & Coronavirus
Strauss and Quarton primarily work with institutional capital sources that provide capitalization for commercial real estate developers and owners. As such, they have a broad view of all debt markets and their willingness to fund.
Debt funds are one of the most affected areas of the financial markets.
Rob Quarton,
Walker & Dunlop
“The way that debt funds finance their position behind the scenes — either using collateralized loan obligations (CLOs), bank warehouse lines or repo facilities — has been hurt by the volatility in the credit markets, which impacted their liquidity and ability to provide financing,” says Quarton.
That, in turn, has caused debt funds to pause their new debt origination or use their own balance sheet capital — a more expensive way to lend money, which has increased debt cost to borrowers. Quarton sees consolidation on the horizon, as there will be fewer active players going forward. Those players continuing in the market won’t have major repo financing issues or difficulties with warehouse lines of credit; this should allow pricing to come back in line with pre-crisis levels.
Another debt sector heavily impacted has been commercial mortgage-backed securities (CMBS), a sector that was already raising eyebrows pre-coronavirus.
“CMBS had some issues securitizing some of their book business and the pools they put together, and that created some kinks, starting in early March,” says Quarton.
In all debt areas, Quarton says that stimulus provided by the CARES Act has created some stability in the markets, allowing for more liquidity in the coming weeks. For many financing transactions in all sectors of commercial real estate, Quarton says, the acquisitions timelines are being pushed out to the third and fourth quarter, if there is flexibility to do so, in the hopes that time will provide clarity on the economic environment.
Pace of Lending During the Pandemic
While lenders had a desire to place capital, a pause occurred about five weeks ago, during a time of higher credit and liquidity uncertainty which resulted in a “gapping out” of corporate bond rates and therefore rates on mortgage debt. Since the aggressive actions of the Fed (providing liquidity to the market and the institution of the CARES Act) rates have come in and mortgage debt and bond rates have returned to a more normal balance.
Debt pricing can fluctuate depending on leverage. Many lenders are on the sidelines. Strauss points out that those lenders still in the market have to meet a certain cost of capital to satisfy their investors.
For borrowers, prior relationships with lenders and a lower degree of leverage are much more important than they were prior to the COVID-19 pandemic.
Meanwhile, the agencies continue to provide capital to the multifamily markets. Fannie Mae and Freddie Mac are, as Strauss explains, “still making loans at the leverage levels and the coverages that they feel comfortable with at pricing — which, in comparison to historical norms — is very attractive. But there are some cases requiring up to a year’s worth of principal and interest reserve. This way, if there is some hiccup in collections, there is the ability to draw on those reserves to make sure the debt service payments get made and the bond holders are paid without putting stress on the servicers.”
COVID-19’s Impact by Property Sector
While it is still early to fully judge the effects of the coronavirus pandemic, it has become readily apparent that some sectors of commercial real estate are more prone to severe impact than others. Retail and hospitality are the most at-risk sectors as shelter-in-place mandates and social distancing limit their ability to function. Office real estate will see limited impact, some of which may end up being more long term as companies adjust to new ways of doing business. Least impacted are industrial real estate and multifamily properties.
With deals currently in the financing pipeline, Strauss and Quarton state that apartments — especially affordable and mission-driven housing — seem to be weathering the storm best. There has certainly been some volatility in the markets, but Fannie Mae, Freddie Mac and HUD are providing liquidity to the multifamily market.
“The underwriting of all the transactions across the board has come under scrutiny,” says Strauss.
And the question of rent collections has come to the forefront for multifamily properties — especially since April has seen stronger collections than anticipated.
“What is May going to look like, and what do people think of the prospects of people returning to work?” asks Strauss. “Will the same 10 percent or so of tenants not paying rent in April not pay in May too? Or could that number balloon because of people’s fear and concern over their ability to pay future months’ rents and cover other costs, like medical bills or buying groceries? Some of that decision will also be affected by the state they live in and their ability to abate rent and not be evicted.”
Such concerns make underwriting a transaction in the pandemic environment tricky.
One of the shining stars of recent weeks has been industrial properties. With most industrial facilities considered essential workplaces that are providing crucial goods, they are still operating. With essential retailers like grocery stores and online delivery services seeing more demand, industrial is likely to see increased interest from investors very quickly.
“Especially in the major metros, industrial — like apartments — has a real operational strength to it,” says Quarton.
The office sector is of high interest, though it varies greatly based on the credit quality of tenants and the ability of said tenants to pay future rents. But beyond that, there loom other questions for office real estate that Strauss points out: will businesses want people to return to office life as normal, with all of the traditional points of contact, if there’s no known solution to the current pandemic aside from social distancing? Will buildings need to look and feel different for life to return to normal?
Positives from the Pandemic?
What might the industry learn from all this?
“Wash your hands all the time,” jokes Quarton.
In addition to time to reflect, there is now time to analyze how underwriting is done, as well as more basic questions like what makes a market good and what trends are likely in the near future.
Technology is coming into play as various teams work to finalize financial deals. Appraisers are using drones to do property inspections and on-site staff are walking through buildings carrying mobile devices and video conferencing the walk-through. Municipalities have also had to respond, in some cases accepting third-party inspections while their own inspection departments are closed. Title companies have pushed for online notarization as well as utilization of electronic filing for titles and recording to close deals. Some title companies have created workarounds in order to allow closings, in spite of many municipal recording offices being closed or operating remotely.
Perhaps a positive of this pandemic situation, Strauss says, will be “people’s understanding that they can use the technologies that are available to them today to do a lot of work. As people get more comfortable working from home, conducting remote meetings and using other collaborative technologies, I think those technologies will be integrated into the normal course of business at a much faster rate than they would have had this event not occurred.”
— By Randy Shearin and Sarah Daniels
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