The effects of the coronavirus pandemic have caused instability and uncertainty in the global financial markets. Businesses are hanging on by the lifelines of PPP loans, while projections estimate the country’s unemployment rate will remain at, or greater than, 10 percent through 2021. For commercial real estate investors, financing will be particularly challenging for the next several months, especially in certain asset classes, such as retail and hospitality. Building confidence with a lender by knowing their hot buttons will increase a sponsor’s success in today’s more cautious environment.
A well-prepared and detailed business plan will go a long way in gaining a lender’s trust. Lenders want reassurance that borrowers have done the research and prepared for potential shifts in the economy as the pandemic plays out. This includes accounting for additional capital expenditures and debt service reserves, along with showing more conservative valuations utilizing true market cap rates and demonstrating untrended rental growth for a period of time. In addition, lenders will want to know the deal works with a higher cap rate on the disposition and an interest rate stress of about 50-100 basis points above today’s rates for a potential takeout loan.
Likewise, sponsors must prepare to underwrite for more conservative leverage. While the maximum loan-to-cost (LTC) ratio for many CRE loans pre-COVID was 75-80 percent, borrowers should expect 65 to 75 percent LTC, depending on the asset class.
Liquidity is king
Whether construction, bridge or a stabilized asset, lenders are placing more focus on a sponsor’s liquidity and global cash flow from other investments. In the past, lenders have typically wanted a borrower to account for an amount equal to at least 5-10 percent of the loan amount in cash and/or marketable securities, in addition to the down payment. This acts as insurance if an unforeseen major property repair is needed. Because of COVID-19, investors and capital partners alike fear a sudden loss of rental income due to tenants vacating or not paying rent, which could inhibit a borrower’s ability to cover debt service and other expenses. Therefore, special attention is being paid to the borrower’s cash position and the overall strength of their portfolio.
Flaunt your resume or find a partner
In the pursuit to relieve lender concerns, borrowers with prior experience will come out ahead. Showing that you had past successes with the particular asset class will mitigate the lender’s risk and strengthen your application.
If a borrower lacks prior experience, acquiring a loan will be challenging in the current environment, especially for ground-up developments. However, tapping a partner can help in multiple ways. In addition to leveraging their past project experience and borrowing history, a partner can help fill in other weak points in a borrower’s creditworthiness, such as insufficient net worth or liquidity. The downside, of course, means splitting the returns with your partner.
Lenders want reassurance
Though raising capital has become increasingly difficult in the past 60 days, the bottom line is that uncertainty and risk are at an all-time high. Lenders have become increasingly more cautious with their funds, waiting for the dust to settle. Borrowers must prepare thoroughly and offer reassurance by tailoring their underwriting and packages to today’s environment.
Adam Finkel is co-founder and principal of Tower Capital. Over the course of his career, Adam has overseen the successful placement of nearly $1 billion in debt and equity financing on behalf of his clients throughout North America. He has a diverse background in both finance, as well as commercial real estate leasing and sales. Adam has earned the designation of Certified Commercial Investment Member (CCIM), and he’s a member of the Forbes Real Estate Council.