A New Normal Emerges in CRE: Breaking Down Deal Flow in COVID-19 Era
By Andrew Mekjavich, Gantry Principal, San Francisco
As we think back to just last March and to the range of emotions felt by all participants of the commercial real estate industry, uncertainty and angst were atop the list. Reactive, and sometimes overreactive, behaviors have subsided, and we all seem to have unknowingly adapted to our new normal. With the evolution of this cycle comes clarity, and one pillar of our business has remained unchanged: attractive debt solutions for quality real estate is still readily accessible for prudent owners. What has changed? As we are sure you all have either read, heard, or experienced, many lenders have become more conservative and are taking a targeted approach to the origination of new loans. Gantry has closed over 130 loans since March and we’d like to share our thoughts and experiences on how deals are getting done and the primary differences we’ve seen in the market today.
For starters, everything just takes a little bit longer. Our long-term relationships with our lenders are important, to both parties. During a time in which lenders are either maintaining their cautious momentum or slowly reentering the market, a system for fully vetting deals all the way up through their chain-of-command has become prevalent. Though some risks are impossible to eliminate up front, ensuring that a preliminary executive consensus exists at the time of a quote is paramount to getting a deal approved and closed. This process takes time, and where loans may have taken days to put under application in a pre-COVID-19 environment, the vetting of a deal is now taking a week or more. Everyone likes things to happen quickly, but getting it right at the outset is advantageous for owners and lenders alike. That being said, all delays are not contained on the lender side of the business, as third-party access issues, COVID-19 questionnaires and requests for additional explanations have become prevalent and simply take more time.
An absolute flight to quality is underway. In this sense, our definition of quality includes choice real estate variables such as core markets, favored asset classes, credit tenancy or stable and diversified rent rolls to name a few. In addition, responsible leverage, borrower strength, tenant caliber and a good story also play critical roles. Real estate with essential uses has become a target for both lenders and owners. Stable apartments, industrial assets, grocery-anchored centers, drug stores, and single tenant investment grade net lease deals have all maintained significant financing activity, while retail and hospitality have inherent challenges. A stable rent roll is the most common theme amongst loans we’ve closed since March. If rents are being paid as initially agreed and most other aspects of the real estate are unchanged, it is challenging to argue that value has decreased with the limited number of recent sales available in the market. With conduit lenders essentially sidelined during COVID-19, a sizeable portion of the life company and bank segments initially on hold, and many debt funds frozen during that period, what did the remaining lenders seek out? You guessed it: quality.
Every property is unique unto itself. As mortgage bankers, we originate hundreds of loans per year on many of the same asset types and would use lender intelligence from one loan and apply it to many others. Unfortunately, that ship has sailed. A magnifying glass is now placed over the many fine details of a specific request in order to generate as much potential lender interest for that deal as possible. Though two requests may appear similar on the surface, very few assets allow for replication of loan quotes with any certainty in today’s market. Our job is to know which of our lenders are active in the market and will likely have an appetite for any given loan. We’ve admittedly experienced more surprise responses in the wake of this pandemic than anticipated, and not all are conservative in nature. Lenders make money by making loans and making loans requires liking some portion of the loans being requested in the market today. We’ve locked in and closed many of the lowest rates in our company’s 30-year history over the last few months. Many lenders are willing to buy the lowest risk with the lowest rate, which interestingly still makes this a borrower’s market despite the present challenges.
Volatility creates opportunity. The health and safety of our employees, families, clients, lenders, and communities have remained our primary focus during this COVID-19 crisis. As the volume of forbearance requests subsided, we noticed a significant uptick of requests generated primarily from bank borrowers unable to execute due to bank bandwidth issues caused by the Payroll Protection Program, along with stringent global underwriting standards being broadly implemented in the bank sector. For borrowers not seeking to maximize leverage, life insurance companies have stepped in and provided surety of execution, long-term fixed rates, limited to no deposit requirements, and, in most cases, a non-recourse basis for the loan.
We anticipate that the general themes of longer timelines, a flight to quality, targeted loan engagements, and new relationship opportunities will continue throughout the balance of this year. Lastly, with modest yet stable production in the Second Quarter of 2020, our production pipeline for loans in process continues to build momentum, which will result in a strong finish to the year, particularly as we identify those lenders who must make up for lost production and salvage their new origination goals due to loan runoff.