By Jerry Zevenbergen & T.R. Hazelrigg IV
Commercial real estate investors will face some difficult days ahead and savvy lenders will need to apply the lessons learned through previous cycles of the credit crunch.
Fifteen years ago, cheap credit and lax lending standards fueled a housing bubble that set off a contagion that led to the credit crisis where banks weren’t even willing to lend to other banks. Today, banks are well- capitalized and structurally sound. However, the uncertainty in the current market is leading many lenders to suspend real estate lending or adjust terms to make financing unattainable for many investors. For those looking to acquire assets under advantageous terms, the advice is to line up your financing in advance and be sure you can comfortably cover your payments.
If your financing is subject to a variable interest rate, perhaps it is time to convert to a fixed rate—even if it is a bit higher or at least negotiate a rate cap. Of course, this depends on the term of the loan. Both rate and term deserve careful consideration. After all, you can only raise rents so much, right?
It is good to keep some perspective. After years of record-low interest rates today’s rates appear high, historically, there were periods with far steeper interest rates. U.S. Prime Rate hit an all-time record high of 21.50 percent on Dec. 19, 1980, in which inflation climbed to 14.6 percent, only breaking with a deep recession.
Debt coverage is going to have an impact on investors’ portfolios and could have a negative impact on the commercial property sector as a whole. Those who can’t meet their debt coverage covenants will default, so try to get ahead of this event by negotiating with your current lender. Communication in advance of a default is key.
Once the loan reaches default, traditional refinancing is not an option. The only way to rectify the situation is to sell the property or take secure bridge financing to avoid a pending foreclosure. With rising interest rates evaporating profit margins, we expect many lenders in the bridge space to sit this cycle out—or close their doors entirely. When rates were low, leveraged funds may have been borrowing against their lines of credit, in turn, lending at a higher rate. The Federal Reserve’s November Financial Stability Report indicates that unknown leverage in the financial system could present significant risks in the future.
We would strongly advise focusing on a proven lender who you are confident will close the loan. Worry less about the rate and more about the certainty of execution. Don’t wait to strengthen your cash position to potentially inoculate yourself against marketplace risks, perhaps selling some assets to reduce your leverage. The adage “cash is king” will become operative as rates continue to tick up. We feel that this economy will be a slog—for the next twelve to twenty-four months.
Past experience informs us what may be coming down the pike. Anyone who can shore up their cash position should do so now. It will benefit them to ride out whatever storm appears on the horizon.
Jerry Zevenbergen is CEO and Co-founder of Avatar Financial Group and is active in underwriting and provides oversight of loan servicing, banking relationships, and financial reporting for the firm.
T.R. Hazelrigg IV is President and Co-founder of Avatar Financial Group, where he oversees loan origination and credit analysis as well as structuring Avatar’s national debt strategies.