The novice approached the two luminaries and asked, “If you could name one thing that is responsible for your success, what would it be?” He expected the billionaire businessmen to speak about the importance of hard work or maybe discuss secret metrics for success. The answer that each provided simultaneously surprised him. It was one word: focus.

“The preliminary discussion to have with a client — before considering any other contingencies — centers on whether a deal has legs.”

Buffett and Gates are legendary for their abilities to cut out all the noise and focus on top priorities. Each of them are incredibly protective of their time and are very selective about what they work on.

Steve Jobs, arguably one of the most successful business leaders of our time, had the same take-no-prisoners focus. When Jobs returned to Apple in 1997 as its CEO, he famously reviewed the scores of product initiatives being pursued at the time and eliminated almost all of them, distilling the company’s focus down to what would become four iconic products.

What does this have to do with commercial mortgage brokers? Everything. Brokers who want to get deals funded and maximize their incomes need to focus on the loan requests that have the highest chances of success. Of course, this is easier said than done.

Picking winners

The most successful mortgage brokers are protective of their time and only focus on viable loan requests. Part of this process is to learn how to spot the winners. Another aspect of the process is being comfortable with saying no. This may entail learning some new habits — or breaking old ones.

When brokers receive loan requests, they need to understand the good, the bad and the ugly of each potential deal. From there, they need to make calls on whether the loans are fundable.

Brokers could go through the files and look for liabilities — tax liens, ownership glitches, credit issues, etc. — and ponder whether these problems can be resolved. Then they could run the numbers to see if the files are workable. But there are other, more efficient ways to get the job done.

Right questions

The preliminary discussion to have with a client — before considering any other contingencies — centers on whether a deal has legs. There are some crucial questions you will need to ask.

Does the loan request fall within the chosen lender’s parameters?A broker needs to determine whether the loan request  is too high or too low for the lender in question. Work with the borrower to hammer out what’s needed in terms of the loan amount or terms. A lender won’t want to fund a deal if the borrower doesn’t have a plan. For example, borrowers who put “max LTV” in their loan requests probably don’t have explicit uses in mind for the additional leverage.

Will the project at hand service the debt at today’s interest rates? One of the first things a lender will do is a debt-service-coverage ratio (DSCR) calculation. Head off an instant rejection by beating them to the punch.

For example, with bridge loan rates hovering in the 11% to 12% range today, do a quick calculation to find out whether the borrower’s income will cover the debt. Brokers can simply take the requested loan amount and multiply it by the interest rate to get a picture of what the annual interest payments will be. Compare this figure against the borrower’s net operating income.

If the proposed loan won’t allow for a positive DSCR, formulate a strategy for the borrower that could make the request more appealing. For example, look at their profit-and-loss statements or tax returns to find items like depreciation or one-time expenses, which can be added back to the equation to enhance net operating income. An interest reserve, which is a capital account created by the lender to fund the loan’s interest payments for a period of time, is another option if the borrower has a solid story.

Right metrics

Brokers also must determine whether the property qualifies under the lender’s parameters. The disconnect between the borrower’s estimate of property value and the appraised value is one of the more common reasons for a deal to fail. Yet the lender’s quote for loan-to-value ratio, cash out and the total funding amount all hinge on this estimate being realistic.

Consider whether the metrics the borrower is using are reliable. For example, the purchase price of the subject property will control the valuation, regardless of whether the borrower thinks the property is worth more. When a borrower says a property is worth $3 million but the purchase price is $2 million, a lender is not going to approve $2.5 million for the purchase.

In addition to valuation, there are many factors related to the property that need to be fleshed out. The location is key for determining population and other demographics. Tertiary markets — some suburban and most rural areas — are difficult to qualify in today’s market and may result in a quick rejection.

Crime statistics can come into play. Take, for instance, a property that was in an area where a resident had a 1 in 13 chance of becoming the victim of a violent crime. The lender passed.

Asset class also can impact a lender’s interest. Office properties are difficult to fund now, so these deals will require extra effort to persuade a lender. Look at all fundamental performance metrics to determine whether the property is worth the time.

It’s always wise to check the borrower’s numbers. Find historical financial reports and see whether the property’s income has gone up or down over the past few years. Resolve the red flags that will inevitably come up during underwriting, so you don’t waste time on a deal that’s not viable.

Borrower qualifications

Does the borrower have the qualifications the lender is seeking? Different lenders have different expectations for their borrowers. For many, prior experience in the asset class is paramount. For others, it’s liquidity, and for others, it’s credit. A common example with a bridge loan is to require the borrower to have a net worth equal to or greater than the loan amount, with liquidity — cash in the bank — that’s at 10% of the loan amount.

The borrower’s character also comes into play for some lenders. A cursory search can uncover a criminal background or a history of litigation. It’s always better to discover these issues before the lender does, so you can let go of a deal with a fatal flaw.

When working with multifamily properties, take a moment to Google the property address to see what the ratings and reviews look like. This is a way to catch badly managed properties and uncover elevated crime statistics. If you find something negative, see if there’s a good explanation for it.

From there, dig in and see if other red flags come up. If the lender likes the borrower’s story, there’s a greater likelihood they may be willing to tackle some problems. But if the deal doesn’t have the fundamentals to begin with, there is virtually no chance of being funded. Why waste time resolving a situation that has no solution?

When you’re speaking with a borrower, learn to focus on what you need to know. This may require reading between the lines. For example, a borrower may offer up a recent appraisal of the property. From their perspective, this saves time and money while proving their valuation claims.

The lender will have a different perspective and several questions. Why do they have a recent appraisal? Was it performed for another lender? Did that lender turn down the deal? What has the borrower done to overcome an objection from another lender?

Letting go

Rejecting a deal is difficult because it’s counterintuitive to turn away business. But relying solely on volume is deceptive. It’s easy to get seduced into thinking that a risky deal is worth a phone call at the very least. One call won’t hurt, right?

Let’s say you have a little extra time. You make a quick phone call to a lender to float a so-so deal. Nothing ventured, nothing gained. One phone call leads to one rejection and zero income. The problem with this habit is that it’s not sustainable. A broker who makes 100 useless calls over the course of a year can wind up with a serious loss of income.

Your time would be better spent honing skills that will allow you to quickly identify the deals that will close. Brokers need to focus their time and resources on these types of deals. Let the others go before they steal your precious time.

It’s also a good idea to periodically evaluate how you get your leads. If brokers find they’re getting stuck with too many loan requests that are no good, they need to explore ways to improve their networking connections and put more time into marketing efforts.

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Commercial mortgage brokers don’t need to be successful billionaires to run their businesses like one. They can thwart the time thief. By focusing only on what’s important, they can improve deal flow, get clients over the finish line and revel in rising income.

At the same time, there are ancillary benefits for brokers who focus on the best deals. These include better business relationships, larger professional networks, and strong reputations with lenders for thoroughness and quality deals that are worth considering. ●

The post Escape the Time Thief appeared first on Scotsman Guide.

These tools, as they continue to advance, are projected to drive a 7% (or $7 trillion) increase in global gross domestic product and boost productivity growth by 1.5 percentage points over a 10-year period, according to Goldman Sachs. Even now, AI and machine learning are revolutionizing the mortgage sector by streamlining processes, improving risk assessment and reshaping the lending landscape.

“Welcome to the future of mortgage origination — a future where AI and machine learning spearhead progress.”

These technologies are making processes more efficient, fueling an era of increased accuracy, reduced risk, and better experiences for lenders and borrowers. Allied Market Research reported that the global mortgage market, which generated nearly $11.5 trillion in 2021, is projected to reach $27.5 trillion by 2031, with a compound annual growth rate of 9.5% from 2022 to 2031. A main driver for this projected growth is the increased investment in software that speeds up the mortgage application process.

Navigating the complexities of this technological evolution will enable the mortgage industry to examine some of its existing challenges while ensuring that the benefits of AI are realized without compromising ethics or fairness in lending practices. Welcome to the future of mortgage origination — a future where AI and machine learning spearhead progress.

Seismic shift

The loan origination process has historically been a labor-intensive and time-consuming effort. Mortgage originators have had to scrutinize mountains of paperwork, verify financial documents and manually evaluate creditworthiness — a lengthy process that could take several weeks. The arrival of AI and machine learning, however, has brought about a seismic shift in how this process is executed, offering a host of benefits.

One of the most notable advantages of AI and machine learning in mortgage origination is the automation of repetitive tasks. Intelligent algorithms can now handle tasks such as data entry, document verification and information extraction that once required substantial human involvement. This cuts the workload for mortgage originators and reduces the chances of errors that accompany manual data entry.

The loan origination process also becomes considerably more efficient with AI and machine learning. Algorithms can analyze massive quantities of data in a fraction of the time it would take a human, facilitating faster loan approval times. Borrowers no longer have to endure long wait times for decisions on their applications, resulting in a more positive experience.

 “Ethical AI development is imperative to avoid bias, discrimination and unfair lending practices.”

In addition, AI and machine learning support a more borrower- focused approach. These technologies enable lenders to provide personalized services and faster response times. A borrower can receive real-time updates on the status of their application, the result of a more transparent and less stressful process.

AI and machine learning algorithms can analyze a multitude of data points far beyond what traditional approaches could accomplish. These technologies consider financial data and factors like borrower behavior and online digital history. This broad analysis results in more informed lending decisions, increasing the probability of approved loans that manual processes may have overlooked.

The adoption of AI and machine learning in mortgage origination can lead to substantial cost savings. Lenders can allocate resources more efficiently and reduce the need for extensive manual labor. These savings can be passed to borrowers through lower fees and interest rates.

Weigh risks

Risk assessment is a pivotal stage in mortgage origination. Traditionally, lenders relied heavily on financial data such as credit scores and income verification. Today, AI and machine learning integration unlocks a wealth of digital data sources, offering a complete understanding of borrower risk.

AI and machine learning are expanding risk assessment capabilities by examining a borrower’s online digital history, which comprises social media activity, mobile device usage, payment systems and online transactions. This provides insights into an applicant’s financial behaviors and lifestyle choices that were not previously visible.

AI algorithms identify elusive patterns and anomalies in a borrower’s digital history, enabling highly informed lending decisions. These algorithms can recognize responsible financial behavior and detect potential issues like erratic income sources or unusual spending habits, considerably minimizing a lender’s default risk.

Additionally, AI acts as a vigilant protector, combating fraud by continually monitoring online activities and transactions. AI quickly detects anomalies and suspicious patterns, safeguarding both lenders and borrowers.

AI’s objectivity and consistency decrease the potential for human error, generating more reliable risk assessments. Customized risk profiles tailored to an individual’s circumstances offer a more equitable lending environment while faster decisionmaking benefits borrowers.

Eliminate errors

Mortgage originators can modernize operations and improve lending practices by implementing AI and machine learning solutions. These advanced technologies can contribute to a more equitable and efficient lending ecosystem by reducing costs, eliminating errors and mitigating bias. Responsible AI adoption supports principles of fairness and accuracy in the mortgage industry while producing multifaceted rewards.

Traditional mortgage origination processes are resource-intensive, requiring ample human labor to perform tasks such as data entry and document verification. AI and machine learning automation markedly reduce the need for manual involvement. This improved operational efficiency gradually lowers overhead costs, aiding originators in allocating resources more effectively.

Manual processes are susceptible to human error — and in mortgage origination, errors can be costly. AI and machine learning excel in consistency and accuracy, eliminating the likelihood of errors in tasks that can be automated. This results in a more dependable origination process, benefiting lenders and borrowers by preventing costly mistakes.

Bias in lending, such as digital redlining, is a challenge associated with these technologies. AI and machine learning systems can be designed for transparency, auditability and continuous fairness monitoring. Ethical AI development practices and diverse, representative datasets ensure that lending decisions are based on objective criteria rather than the perpetuation of historic biases. Systematic audits and oversight are key to maintaining fairness and compliance.

Prudent navigation

The adoption of AI and machine learning in mortgage origination produces transformative benefits, but unique challenges call for prudent navigation. Because AI and machine learning greatly depend on borrower data for risk assessment and automation, ensuring the privacy and security of data is paramount.

Lenders must employ robust data encryption, secure storage practices and strict adherence to data protection regulations. Building trust through transparent handling practices is critical to assure borrowers of their data’s safety.

Ethical AI development is imperative to avoid bias, discrimination and unfair lending practices. Using diverse and representative datasets for training, routinely auditing algorithms for fairness, and maintaining transparency in lending decisions are critical steps in establishing ethical AI practices and ending digital redlining.

The highly regulated mortgage industry demands strict adherence to rules and standards. AI and machine learning integrations must align with these regulations, requiring close collaboration with legal experts to certify compliance, particularly when AI-driven decisions have financial implications for borrowers.

Maintaining transparency in lending decisions is of great importance since AI and machine learning algorithms operate in ways that can be difficult to understand or interpret. To build trust, borrowers must have explanations for how these technologies are used in lending processes.

While automation is a key advantage, human oversight remains essential. Striking the right balance between automation and human intervention affirms that AI-driven decisions support organizational goals and consider complex cases or exceptions.

AI and machine learning technologies evolve rapidly. Keeping pace with advancements and adapting systems accordingly are ongoing challenges. Investments in ongoing training — and having a keen eye for evolving best practices — are vital to remain competitive and compliant.

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Integrating AI and machine learning into mortgage origination marks a profound shift in the lending landscape that offers promise, opportunity and challenges. AI and machine learning will modernize the origination process by providing operational efficiencies, faster approval times and better client experiences.

Borrowers benefit from faster decisions while lenders enjoy cost savings and enhanced accuracy. By implementing these technologies responsibly and addressing challenges diligently, mortgage originators can lead the industry toward a more competitive, compliant and borrower-centric future. ●

The post The Sky’s the Limit appeared first on Scotsman Guide.

“Lenders, brokers and third-party processors must work in harmony, leveraging each other’s strengths to fortify the industry against emerging challenges.”

The mortgage industry has a rich history of weathering economic storms, regulatory changes and market fluctuations. But today’s rapidly changing landscape demands more resilience than ever. This calls for a tactful approach to navigate not only the predictable market cycles but also potential shocks like global financial crises or unforeseen natural disasters.

At such times, building a robust foundation is a must. A strong foundation can withstand the tremors of change while committing to provide access to homeownership opportunities for individuals and families. Efficient processing solutions can be instrumental in strengthening your foundation and helping you effectively navigate the mortgage market.

Client satisfaction

Mortgage processing is a labor-intensive and time-consuming process. From application compilation, document verification, appraisal and property review to underwriting analysis, title examination, conditions fulfillment and final approval, there are numerous steps involved. For an organization looking to increase efficiency without hiring more staff and adding more resources to streamline the process, partnering with a third-party provider can be vital.

Third-party mortgage processing companies are the unsung heroes of mortgage businesses trying to reduce costs and optimize operations. Their expertise and services play a pivotal role in supporting lenders and originators, ultimately contributing to the industry’s stability. According to a 2019 McKinsey & Co. survey, only 42% to 67% of borrowers express satisfaction with the mortgage process, with banks often trailing behind nonbank lenders by 10 to 20 percentage points.

Why do you need to care about borrower satisfaction? The short answer is to gain more clients. The better the experience you’re able to offer your clients, the more likely they are to recommend you. Partnering with a third-party processor can enable you to focus on strengthening your customer relationships while they take care of your daily operations.

Streamline operations

Efficiency and speed are two cornerstones of an agile mortgage industry. Mortgage processing companies excel in helping lenders and brokers streamline their operations. By leveraging the latest tools like business intelligence dashboards and a dedicated workforce, these companies can significantly reduce the time it takes to process mortgages.

Let’s say you process roughly four loans a month given how much time processing requires. When you work with a processing company, you can work on at least six or seven loans a month because your paperwork is being taken care of while you secure more business. Quicker loan processing times not only lead to improved borrower satisfaction but also make the industry more resilient in a competitive market.

In a rapidly changing environment, borrowers and loan originators alike demand a mortgage process that keeps pace with their expectations. Third-party mortgage processing allows lenders to meet these demands head-on, gaining a competitive edge and fortifying their position in the market.

Cost-effectiveness is another area where third-party mortgage processing companies shine, particularly during challenging economic conditions. In times of economic uncertainty, lenders must closely monitor their expenses to ensure long-term stability. Outsourcing mortgage processing can be a strategic move in this regard.

By partnering with third-party processors, lenders can access cost-effective solutions that minimize overhead costs associated with in-house processing. For instance, an experienced mortgage processing partner would know the importance of reauditing loan documents. Identifying and rectifying errors after an audit can potentially increase gross margins and profits by reducing the risk of investor suspensions and repurchases.

Specialized expertise

The ever-evolving regulatory landscape presents a significant challenge for mortgage lenders and brokers. It is a processing provider’s responsibility to ensure compliance with a complex web of solutions. Third-party mortgage processing companies excel in this area by offering specialized expertise in compliance and risk management.

These companies invest heavily in staying up to date with regulatory changes, ensuring that their lender and broker partners always remain compliant. By mitigating potential risks and facilitating adherence to regulations, third-party processors shield against legal and financial threats. This allows for more stable operations by minimizing disruptions caused by regulatory noncompliance.

“For an organization looking to increase efficiency without hiring more staff and adding more resources to streamline the process, partnering with a third-party provider can be vital.”

Market conditions can be unpredictable with fluctuating lending volumes. By outsourcing processing tasks, loan originators can quickly adapt to market fluctuations without the need for extensive internal restructuring. In situations when the Federal Reserve increases interest rates to meet its inflation targets or when the unemployment report presents discouraging numbers, the housing market feels the heat. Third-party processors can seamlessly adjust their services to meet their clients’ needs.

In the age of data, the ability to harness information for smarter decisionmaking is paramount. Many third-party mortgage processing companies offer advanced data analytics and reporting capabilities like credit risk assessment, loan origination analysis and market research, to name a few. Lenders can gain valuable insights into their operations and portfolio performance, helping them make data-driven decisions.

These insights enable lenders to identify areas for improvement, optimize their processes and proactively address potential issues. In doing so, they can stay ahead of challenges rather than merely reacting to them.

Collaborative efforts

Looking ahead, it is increasingly evident that the mortgage industry’s resilience will hinge upon the strength of its collaborative efforts. The partnership between third-party processing companies and industry professionals will play a pivotal role in shaping the mortgage ecosystem of the future.

Collaboration is the bedrock upon which industry resilience is built. Lenders, brokers and third-party processors must work in harmony, leveraging each other’s strengths to fortify the industry against emerging challenges. This symbiotic relationship can result in a seamless mortgage process that not only meets but exceeds borrower expectations.

The role of third-party mortgage processing companies is poised to evolve further, becoming even more adaptive and responsive to industry needs. Their ability to rapidly adapt to the latest tools and processes, regulatory changes and market dynamics will be a critical asset in future-proofing the mortgage industry.

The outlook for the industry is bright if lending professionals recognize the vital role of collaboration and embrace the evolving capabilities of third-party processing companies. Together, they can build a resilient mortgage ecosystem that not only withstands the tests of time but also paves the way for continued growth and innovation. ●

The post These Unsung Mortgage Heroes Can Reduce Costs appeared first on Scotsman Guide.

These skills enable brokers to estimate and analyze financial performance, return on investment and property value while negotiating deals more effectively. Quick calculations of the net operating income, the capitalization rate or the debt-service-coverage ratio, for instance, will enable the mortgage broker to demonstrate a higher level of professionalism to a potential client.

“There are about 25 commonly used financial ratios. Several of these are regularly employed when analyzing the performance of a potential commercial real estate investment.”

While these skills may be rudimentary for veterans of commercial real estate finance, those who are new to the business — or even a residential mortgage originator who dabbles in commercial deals — will need to immerse themselves in the basics. A solid grasp of accounting is useful when participating in this field.

Investment analysis

At the heart of financial analysis is an understanding of the financial ratios that measure the relationship between two or more components in a company’s financial statements. These ratios provide a way to track a property’s performance compared to industry standards, identify potential problems and offer a basic report card on management.

There are about 25 commonly used financial ratios. Several of these are regularly employed when analyzing the performance of a potential commercial real estate investment. The following list of terms is not all-inclusive but offers some key areas that can greatly benefit commercial mortgage brokers in their day-to-day business endeavors.

The objectives of financial statements are to provide information about the fiscal performance and changes in the financial position of an organization. This information is crucial when making business and investment decisions.

Financial information is presented in a standardized manner through a set of accounting rules and standards for financial reporting known as Generally Accepted Accounting Principles (GAAP). Much of the information about a company will be found in three common financial statements: the balance sheet, income statement and statement of cash flow.

Balance-sheet basics

The balance sheet is one of the most essential tools in the analysis process. It provides a detailed report of a company’s assets, liabilities and shareholder equity at a specific time, such as the end of the year.

This statement, however, does not show the trends playing out over a longer period of time. Consequently, the balance sheet should be compared with previous periods. By using financial ratios to examine the balance-sheet information, additional insights can be uncovered about a property’s financial condition.

The balance sheet places assets on the left side of the equation, with liabilities and shareholder equity on the right. The resulting equation is assets = liabilities + equity. The accounting equation can be read as assets – liabilities = equity.

The balance sheet is divided into current assets (converted into cash in one year) and long-term assets (converted into cash beyond one year). The accounts are arranged according to their liquidity and the ease with which the assets can be converted into cash.

A liability is any debt a company is obligated to pay. This may include debts to lenders and suppliers, rent and salaries. Long-term liabilities include the total amount of any debt due beyond one year. This will include all debt that’s amortized over a multiyear period.

Current liabilities include the portion of debt due within the next 12 months. As an example, if a company has nine years left on a mortgage for its office building, one year of this obligation is classified as a current liability and the remaining eight years as a long-term liability.

Digging deeper

Other aspects of the balance sheet include equity, which is the net asset value for the shareholders of a business. Net assets are the total assets minus liabilities.

Don’t overlook the balance-sheet footnotes. These offer information on assets, debts, accounts, contingent liabilities and background details to explain the financial numbers.

“These skills enable brokers to estimate and analyze financial performance, return on investment and property value while negotiating deals more effectively.”

An income statement is another essential part of reporting a company’s financial performance. The income statement shows the total income generated, all related expenses, and the resulting profit or loss during a particular period (such as a month, quarter or year). This statement provides insightful knowledge of a firm’s operations and performance in relation to prior periods and industry peers.

Also crucial is the cash-flow statement, which is a report that reflects the amount of cash a company generates from its ongoing operations. It might be the most valuable of all statements since it tracks cash flow through the business in three key ways: operations, investments and financing.

Measuring profitability

A key financial metric used to measure the profitability of an investment property is net operating income (NOI). It represents the income generated by the property after the operating expenses are subtracted. To calculate NOI for commercial real estate, subtract the property’s operating expenses from its gross rental income.

Operating expenses include property taxes, insurance, maintenance, repairs, utilities and property management fees. NOI is used by lenders to determine the maximum loan amount they’ll approve based on the property’s income-generating capacity. (In equation form, NOI = gross rental income – operating expenses.)

The debt-service-coverage ratio (DSCR) measures the cash flow available to service the property’s debt. It is calculated by dividing NOI by the annual debt-service payments. A property with NOI of $750,000 per year and debt service of $600,000 per year has a ratio of 1.25 (DSCR = net operating income / total debt service).

A DSCR of 1.0 means the property generates enough income to cover its debt obligation. A ratio of 1.25 or higher is normally considered an adequate ratio for commercial real estate investments.

Measuring risk

A property’s net operating income is also used to determine the capitalization rate, or cap rate, which measures the anticipated return on a property’s investment income. It is calculated by dividing the property’s NOI by its market value.

Take, for example, an investor who wants to purchase a shopping center that generates $375,000 in net operating income and is valued at $7.5 million. The formula is cap rate = net operating income / property value, which in this example would equal 5%. This means that the property generates a 5% return on investment based on its income.

An investor can also calculate property value based on a desired rate of return. Using a 5% cap rate, the value of the same shopping center can be estimated as follows: value = NOI / cap rate. In this case, the value equates to $7.5 million.

The cap rate is useful for comparing the relative values of different commercial properties. A higher cap rate generally indicates a higher return on investment, but it’s also typically associated with higher risk.

Measuring returns

Two more key terms to remember are return on investment (ROI) and cash-on-cash (CoC) return. ROI is used to measure the profitability of an investment. It is determined by dividing the net income by the total amount invested. The higher the ROI, the better the deal for the owner.

Finally, to measure the cash income earned from invested capital, a broker can use the cash-on-cash return. CoC is calculated by dividing a property’s annual pretax cash flow by the total cash invested.

For instance, let’s say an apartment building costs $7 million with a $1 million downpayment. The building generates $150,000 in annual pretax revenue, so the CoC return is $150,000 divided by $1 million, which equals 15%.

The CoC return means that the cash income earned on the building is 15% per year. Once again, the higher the return, the better the investment.

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The various ratios discussed here are important tools for analyzing the financial performance of commercial real estate. Like all tools, however, there are limitations. They are often based on past performance, may lack comparable data and may not offer enough information to identify an emerging trend. They also don’t reveal all of the relevant information about a company’s past, present or future.

Successful commercial mortgage brokers will use these tools and more to analyze a client’s investment prospects. Brokers need to understand a property’s history and be able to speak the language of financial analysis in the business environment. In other words, to know your numbers is to know your business. ●

The post Know Your Numbers appeared first on Scotsman Guide.

One thing is certain: AI is here to stay — and in a big way. Commercial mortgage originators wondering how they can implement artificial intelligence into their operations have numerous opportunities to embrace these powerful tools. The main reason why AI technology is becoming so prevalent across industries is its ability to process data while making connections more quickly and efficiently.

While the applications of such technology are obvious in more technical industries, some may not realize how this improved data processing could have tremendous impacts for commercial mortgage companies. From research and discovery to marketing and valuable lead generation, virtually every stage of the originator’s job (except for the deal itself) can be streamlined and improved using AI technology.

Efficiency tool

Experts in developing and using AI are commanding seven-figure salaries, with major companies such as Netflix offering salaries of up to $900,000 for an AI product manager. Even traditionally “human” jobs are being transformed by AI’s expanding capabilities in the use of natural language processing (NLP).

Still, it’s important to note that these efforts do not necessarily mean replacing people. In fact, AI itself is playing a role in providing personalized training in India. It also supports reskilling and upskilling of some workers who are learning how to incorporate AI into their workflows to increase output.

Those who embrace this new paradigm can remain ahead of the pack, while those who fail to recognize its potential could struggle to hold their own against competitors who do. This is particularly true in commercial real estate finance and other client-facing roles.

When it comes to the commercial mortgage sector, there’s one main way that artificial intelligence is being implemented — as a tool for employee productivity and efficiency. While these applications are occasionally client-facing, some of the most exciting AI-powered features are those used for administrative tasks.

One interesting use of AI is in the loan underwriting process. The technology can prefill and analyze application forms, saving the originator time and resources. AI can also look for anomalies and alert the originator to any problems.

Because of the improved data processing capabilities of AI compared to humans, such a program can help brokers close more quickly and successfully. Even more exciting is that these programs can reveal the lending opportunities that an originator may have otherwise overlooked or not had access to.

Industrywide impact

Predictive insights are another area in which artificial intelligence could prove particularly useful. Using AI technology, originators can accurately and efficiently comb through large datasets, allowing them to provide the most curated and customized opportunities for their clients. When purchasing commercial real estate, fit is paramount, and these in-depth analytics ensure that originators can provide the best service possible to their clients.

Like many other industries, AI is also being used by commercial mortgage professionals to automate some of the more monotonous tasks of their jobs, such as office work. Leveraging AI and NLP, loan originators can use this technology as knowledge agents or researchers to help them with the earlier stages of finding or marketing opportunities. They can also automate tasks such as customer service and lead generation. By using artificial intelligence in this way, originators can focus more of their time on what they do best: closing deals.

This technology is not just for filling out forms either. Many believe AI will revolutionize commercial real estate by integrating the technology into every facet of the industry, including interactions with customers, predictive analytics and automated property management systems.

The transaction experience could be improved significantly due to the proliferation of AI-powered tools, such as chatbots like ChatGPT. By setting up chatbots for prospective clients to interact with, mortgage brokers can create a 24/7 resource that offers clients the basic information and answers they may be looking for. These tools can also collect client information for the originator to use in the future.

Human element

As is the case in virtually every industry, the human element will have to remain involved. A big part of what makes for successful commercial real estate deals is an originator’s ability to form connections and relationships with their clients, and AI is unable to replicate this human factor. AI is also ineffective at accurately timing the life of a deal, which is where brokers bring their edge through intuition and experience.

Thus, it’s best for originators to look at AI as a supplemental tool they can use to make their jobs easier and more efficient, rather than as a replacement for their profession. By implementing these tools into their daily operations, commercial mortgage originators can waste less time on paperwork, empowering them to spend more time focusing on their strategies, negotiations and client relationships.

It will also be interesting to see how artificial intelligence can improve the experiences of people purchasing commercial real estate as the market heads into more uncertain economic times. With higher interest rates and lower demand in some real estate sectors, originators can use these powerful AI tools to ensure the best possible opportunities for their clients. In this way, originators can remain a few steps ahead of their competition and the market at large.

More commercial real estate transactions bring value not only to the broker and borrower but also to surrounding businesses. For example, if an office building is occupied, local restaurants will benefit through increased customer traffic from these workers. Beyond the commercial real estate industry itself, the use of AI could have profound implications for the broader economy. Enterprise AI systems could enhance employee efficiency and happiness, leading to better retention and overall output.

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Like other businesses, it’s critical for commercial mortgage companies to understand the edge that artificial intelligence will give them over their competition. They should begin investing time and energy to improve their current workflows. In doing so, loan originators will not only improve their own experiences but those of their clients too. This could benefit many others given the important role that commercial real estate plays in the broader economy. ●

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“As a mortgage originator, you can instill confidence in your clients by offering a proactive solution that directly contributes to their financial well-being.”

Credit can be a minefield, but armed with the proper knowledge, you can help first-time homebuyers sidestep the money traps in wait. You’ll need to delve into the granular details of these traps, provide real-world examples, and offer practical solutions that empower you and your clients to make informed decisions.

Accurate assessment

Imagine a builder laying the foundation of a house without assessing the ground beneath it. Similarly, prospective homebuyers who don’t scrutinize their credit reports set themselves up for disappointment.

Encourage your clients to obtain credit reports from all three major bureaus — Equifax, TransUnion and Experian — and review them for inaccuracies. Even a minor error can lead to a higher interest rate or an outright loan rejection. Advise your clients to request their free annual credit reports and dispute any inaccuracies they find. A clean and accurate credit report is the bedrock of a solid financial foundation.

At the same time, many prospective homebuyers may neglect credit utilization. Think of credit utilization as the delicate balance between water and a boat. Too much water (high credit utilization) can sink the ship (credit score), while too little water can leave it stranded.

“Credit can be a minefield, but armed with the proper knowledge, you can help first-time homebuyers sidestep the money traps in wait.”

First-time buyers often fail to realize the impact of credit utilization on their scores. Encourage them to keep their credit card balances below 30% of the limit. Recommend they pay down high balances before applying for a mortgage. Doing so can improve their credit score and increase their chances of securing a favorable loan.

In the excitement of purchasing a new home, clients may be interested in offers for new credit cards or financing. Each new credit application triggers a hard inquiry, which can temporarily lower their credit score. Moreover, the average age of their credit accounts will decrease, potentially affecting their creditworthiness. Advise clients to hold off on opening new credit accounts until their mortgage is secured. Patience can pay off with a more robust credit profile.

Just as a homeowner wouldn’t demolish a structurally sound room, clients should be cautious about closing old credit accounts. The length of their credit history contributes to their credit score, and closing old accounts can shorten this history, potentially leading to a lower score. So, encourage clients to keep their old accounts open, even if they don’t use them regularly. A diverse and established credit history is a valuable asset.

Late or missed payments are like cracks in a home’s foundation, weakening the overall structure. One late payment can significantly dent a credit score and raise a red flag for lenders. To solve this, stress the importance of making payments on time, every time. Urge clients to set up reminders or automatic payments to stay on track.

Careful planning

Picture a homebuyer standing at the edge of a cliff, unable to proceed because they didn’t plan their route. Similarly, clients who don’t plan their credit moves ahead of the home purchase process might find themselves in a tight spot. So, suggest that clients get their credit in order at least six to 12 months before house hunting. This process may include paying down debts, resolving outstanding issues and building a solid credit history.

Some prospective borrowers, especially parents, may be inclined to co-sign loans for family and friends. Co-signing a loan might seem like a gesture of support, but it can have far-reaching consequences. The co-signed debt appears on your client’s credit report, potentially affecting their debt-to-income ratio and creditworthiness. Advise clients to carefully consider the implications before co-signing a loan. They must know their credit can be negatively impacted if the primary borrower defaults.

Closing costs can be a rude awakening for first-time buyers. It is essential to account for these expenses as they work to afford the upfront costs of homeownership. Educate clients about the closing costs of a home purchase. Advising them to have an emergency fund can help them navigate this financial hurdle.

Securing a preapproval is a green light for many clients to start shopping for their dream home. But they need to remember that their preapproval is based on their current financial situation. Warn clients against making significant purchases or taking on new debt after preapproval. These actions can alter their financial picture, jeopardizing the final mortgage approval.

Imagine adding extra support beams to a house, strengthening its foundation. In the realm of credit, first-time homebuyers often overlook an invaluable opportunity to fortify their profiles by including nontraditional data such as rent payments, cell phone bills and utility bills. While landlords aren’t obligated to report on-time rental payments, credit bureaus offer programs that make it a breeze to add this data. One such game-changer is Experian Boost, which opens the door to significant credit score enhancements by factoring in these previously unaccounted-for payments.

As a mortgage originator, you can be the bearer of exciting news to your clients. Have them explore options like Experian Boost to tap into this hidden potential. This tool allows them to grant permission for the credit bureau to access their bank account and identify eligible payments. Your clients can add up to 24 months of past rent payments to their credit history, potentially turning this often-missed credit-building opportunity into a formidable advantage.

Potential boost

Imagine a client, Emma, who is excited about purchasing her first home. Her credit score, however, is hovering slightly below the threshold for favorable mortgage terms. But there are ways that you can help her. Mortgage originators have an opportunity to introduce clients to an invaluable credit-boosting tool.

Upon your recommendation, she explores Experian Boost and adds 24 months of consistent rent payments to her credit report. Her credit score climbs by 40 points in only two months, opening doors to better interest rates and loan options. Emma’s journey is a testament to the real-world impact of proactive credit-building strategies on a first-time homebuyer’s dreams.

Here’s how it works: Clients grant permission to access their bank account transaction data. The access needed is solely to identify eligible payments that can be included in their credit profile. The credit bureau analyzes the transactions and identifies recurring payments such as rent, cell phone and utility bills. These payments are generally not reported to the credit bureaus through traditional means. TransUnion has a similar version called TruVision, while Equifax works with third-party vendors to report this information.

The credit bureau then presents a list of identifiable charges to the client for confirmation. The consumer has complete control over which payments they want to include in their credit report. Once the client confirms the charges, the data is incorporated into their credit profile. This additional information can have a notable impact on their credit score.

Experian reports that, on average, clients who use Boost see an instant credit score improvement of 13 points, but it can eventually range up to 50 points or more. This enhancement can lead to more favorable loan terms and interest rates. The increase doesn’t take years to materialize. Many clients experience the benefits within 45 to 90 days, making it a relatively quick solution for those looking to buy a home soon.

For first-time buyers, these credit-building tools can help create a more positive credit history. The inclusion of timely rent payments showcases responsible financial behavior that lenders appreciate. As a mortgage originator, you can instill confidence in your clients by offering a proactive solution that directly contributes to their financial well-being.

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Mortgage originators are not only financial guides — they’re also navigators of the turbulent waters of credit and homeownership. With these insights, you can empower clients to make intelligent financial decisions.

Each avoided trap brings them closer to achieving their dreams of a new home without the credit quagmires that often sink the unprepared. So, go forth and be the beacon of credit wisdom your clients need to walk their homeownership path with confidence. ●

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Still, finding ways to shorten the lending process is a worthwhile endeavor that benefits the borrower, broker and lender. One of these paths is through greater understanding and adoption of blockchain technology, an advanced digital database that can be shared by all stakeholders in a real estate transaction. When Fannie Mae polled hundreds of senior mortgage executives in late 2021, it found that only 25% of respondents were at least “somewhat familiar” with blockchain and 68% had yet to consider using it in their organization.

“Technology is only as good as your ability to fully implement it and embrace it.”

– Devin Caster, principal of product solutions, CoreLogic

“Many mortgage operating models still grapple with elevated costs and long cycle times,” according to a December 2021 report from McKinsey & Co. The consulting firm estimated that the typical processor and underwriter close 10 to 14 loans per month, numbers low enough that the average time for an individual loan to make it from application to close remained at more than 45 days.

These slow-moving processes are costing lenders in multiple ways. Production expenses soared to a record high of $13,171 per loan in first-quarter 2023, according to the Mortgage Bankers Association (MBA). Even after receding to $11,044 per loan by midyear, this figure was still well above the long-term average of $7,236. The McKinsey report, meanwhile, revealed that customer satisfaction scores across the mortgage industry are up to 40% lower compared to “best-in class industries” and up to 30% lower when comparing banks to fintech-enabled lenders.

The Mortgage Industry Standards Maintenance Organization (MISMO), an MBA subsidiary, released a white paper this past June that discusses the potential uses and benefits of blockchain technology. Along with increasing transparency and trust in loan servicing and securitization efforts, the group outlined ways to make the origination process more efficient.

MISMO estimates that blockchain’s ability to serve as a “single source of truth” could reduce closing times by at least 30% and cut costs by at least 25%. The technology is designed to reduce the time spent validating information in a loan origination system, since data such as credit scores, collateral values and underwriting requirements reside on a secure and immutable chain.

Devin Caster, a former underwriter who now serves as principal of product solutions at CoreLogic, says that he used to be able to churn through 10 to 12 loan files each day. These numbers began to decline after the passage of the Dodd-Frank Act in 2010 and were further hampered after integrated disclosure rules were enacted in 2015. But Caster, a co-chair of MISMO’s blockchain community of practice, thinks that loan processing timelines should be faster despite today’s regulatory hurdles.

“To me, human nature should dictate that somewhere along the line, you keep repeating patterns over and over again, you start getting better and faster at them,” he says. “And it’s just not happening in that particular space.”

Shawn Jobe, vice president and head of business development at Informative Research, also co-chairs the MISMO blockchain community. The group’s current “exploration phase,” he says, is designed to identify ways for blockchain to solve real-world mortgage banking challenges. MISMO plans to eventually leverage its own work products (including a data standard, a business process model and advanced programming interface tools) to study connections between various blockchain systems.

“We are still an industry that is heavily dependent on that philosophy of, ‘You’ve got to check the checkers,’” Jobe says. “The technologies and the capabilities that come within blockchain directly meet that need.”

Caster believes that efforts to integrate blockchain, like other types of technology, are likely to be bumpy and slow-moving. He says that tools such as digital asset verification, employment verification and income calculators have faced opposition from originators and underwriters.

“If they don’t trust it, they’re not going to rely on it,” Caster says. “With blockchain, if you’re able to bring in a lot of smart-contract type of automation, but they’re unable to change the processes and put trust in the processes, then they’re not going to gain the efficiencies. Technology is only as good as your ability to fully implement it and embrace it.”

Although blockchain has yet to earn widespread adoption in the industry, there are some prime examples of successful integrations. Figure Technologies has utilized blockchain to originate more than $6 billion in home equity lines of credit and recently began partnering with four major independent mortgage banks on proprietary HELOC products with a 100% digital application process. Last year, Redwood Trust subsidiary CoreVest securitized $313 million in single-family rental loans, with blockchain provider Liquid Mortgage providing the ability to track daily loan-level payment activity.

Jobe cautions that the technology has limitations. For example, he’s unaware of anyone using it to directly reduce the time to close, although that’s likely to change eventually. And blockchain can’t force consumers to engage, which can negatively impact closing times even if a mortgage company is 100% digital. “There’s just a multitude of factors that are going to potentially influence that,” Jobe says. “Blockchain is not a magic wand. It’s not the silver bullet. It’s going to help with very specific pieces.” ●

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One newly revealed option in Fannie Mae’s appraisal modernization effort is the valuation acceptance + property data alternative that waives the need for a desktop or full appraisal for certain loans. This is Fannie’s equivalent to Freddie Mac’s ACE + PDR (automated collateral evaluation plus property data report). Fannie’s guide also offers alternatives to expedite the 1004D final inspection for completion or repair.

“Lenders are still on the hook for ensuring property eligibility requirements are met before the loan can be sold.”

The valuation acceptance plus property data option allows Fannie’s original value acceptance appraisal waiver to be extended to a broader range of properties. This is because it includes the submission of current property data to bolster valuation confidence and lower risk. Fannie’s property data report will contain photos, an appraiser-grade floor plan of the home, and a questionnaire that details the materials and condition of the property.

This alternative is one step above a pure appraisal waiver and slots below a traditional desktop or hybrid appraisal. By using property data inspectors (a presumably less expensive option than full appraisers), borrowers could save money and more properties could become eligible to receive less than a full appraisal, benefiting lenders and consumers with greater speed and lower costs.

Anticipated workflow

Conceptually, the process works as follows: The loan is submitted to Fannie Mae’s Desktop Underwriter (DU), which determines if it’s eligible for the valuation acceptance plus property data alternative. If it is, a lender orders a property data collection report from an appraisal management company. A property inspector is scheduled to physically visit the property, collect the data and images into a digital format using a handheld device, then submit the information to the vendor. Next, the vendor will submit the inspection data to Fannie Mae, where the lender can access the information to view or print.

To aid adoption of the new guidelines, Fannie Mae published a fact sheet. It contains a representations and warranties chart. At the top of one column are the words “property description,” with an asterisk. The associated disclaimer reads: “The lender remains responsible for the accuracy and completeness of all data that pertains to the property and project (if applicable) that is submitted to DU (other than the property value).”

In other words, the quality and veracity of this new option is the full responsibility of the lender. This means it’s incumbent upon lenders to vet and engage qualified inspectors to capture the required geotagged data and images of the property’s exterior and interior, as well as review the submission data to ensure there are no issues that may affect the sale of the loan to Fannie Mae.

Furthermore, lenders must be able to produce evidence that the property data collectors are professionally trained, comply with fair lending laws, and are able to deliver unbiased and accurate results. They must also perform, or ensure that their providers perform, an annual background check on their data collectors and that a property inspector “has no interest in or ties to the underlying loan origination transaction, participants or subject property.” Ergo, lender operations and vendor managers will need to add property inspector network development and management to their roles and responsibilities, or engage with an appraisal management company that provides these services.

Lenders will also have to prepare for the inevitable exceptions to the process. Specifically, when loan conditions change, the value acceptance waiver may be withdrawn, and processors may have to pivot mid-flight by upgrading to a hybrid or full appraisal. In such cases, they will then need to engage an appraiser and determine whether the information obtained can updated and used in a hybrid appraisal, or whether they will order a full appraisal report.

There may be some instances where an appraiser is unavailable or unwilling to perform a hybrid report using the data, so lenders should also remember that they always have the permanent backstop of being able to order a full appraisal on any loan regardless of the Desktop Underwriter decision they see.

Potential savings

Ostensibly, sending an inspector to collect and submit property data and images via an app will cost less than a professional appraisal. By some estimates, the savings will amount to $100 to $150 per loan for the borrower. The real answer will depend on whether a property ends up requiring a hybrid appraisal upgrade (if a waiver is withdrawn) or a full appraisal.

According to a survey of vendors, inspection fees for a valuation acceptance plus property data report could be as low as $225 or as high as $350. For discussion’s sake, let’s say a lender pays $250 for an inspector to do a site visit to gather the data and images. If the valuation requirement is upgraded to a hybrid or traditional appraisal after the data is collected, the lender must then hire an appraiser to complete the necessary report. This will add another fee, $275 to $350 on average, on top of the $250 paid to the inspector — bringing the total to $525 or more in most cases.

The real impact on costs will be clearer once there’s a better understanding of the percentage of eligible loans that qualify for the valuation acceptance plus property data option versus the percentage that will still require a hybrid, desktop or full appraisal. The initial estimates from various industry experts are that the program will first be applied to an estimated 3% to 10% of loans, centering on single-unit properties for limited refinance and purchase transactions. As the program matures, this estimate scales to substantially higher percentages, including the addition of hybrid appraisal approvals added to property data collection.

As the program matures, the estimate is expected to grow to a much higher percentage of all loan volume in subsequent years. If one assumes that at scale, 40% to 50% of all potential loans could be eligible for these programs, the aggregate savings to borrowers could be significant. Savings for lenders may be more elusive since they will still need to hire and manage the operations, vendor and processing resources needed to support this new alternative.

Risk tolerances

Lenders will also need to examine and evaluate how the valuation acceptance plus property data option affects their own underwriting risk tolerances and processes. Remember, Fannie Mae’s representations and warranties are tied only to value. Lenders are still on the hook for ensuring property eligibility requirements are met before the loan can be sold to the agency.

That’s why underwriters need to have complete confidence in the inspectors who gather the data and images. Strict protocols that verify the accuracy and thoroughness of each inspector’s work should be an imperative.

Normally, if a property needs repairs, the lender asks the appraiser to do a second inspection (often remotely), then uses an appraisal update and completion form to verify that the repairs have been completed. But with the valuation acceptance plus property data option, there is no initial appraisal to update. Instead, a lender may obtain a letter from the borrower attesting that the repairs have been completed, along with photos, signatures of the professionals who performed the work and/or paid contractor invoices.

Borrowers also appear to be required to embed a link to the photos in their attestation letters so that Fannie can access them now or far into the future. If the loan is submitted without proper and verifiable attestation and exhibits, the lender could wind up having underwriting issues with Fannie Mae.

Fannie Mae personnel have indicated that the borrowers themselves will provide all of this information regarding proof of repairs without lender assistance. As with any new process, however, there will be plenty of learning and refining as lenders figure out how to integrate the valuation acceptance plus property data alternative into their processing and underwriting workflows. ●

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The commercial mortgage industry has had to pay close attention given that its turnover rate is already high and teams are thin. While borrower demand has provided consistent opportunities for mortgage brokers, other factors such as increased interest rates, continued project delays and high prices for construction materials make it more challenging to identify properties that are worthy of investment.

“Mortgage company leaders are responsible for ensuring that team members get the support they need, otherwise they risk losing employees.”

Global real estate leaders are also feeling the pinch as the outlook for growth potential is gloomy compared to this time last year. Only 40% of real estate industry leaders expect revenue growth in 2023, compared to 80% heading into 2022, according to surveys conducted by Deloitte. In this environment, having and keeping the right people in place is critical, and being able to do more with less is even more important.

Why employees leave

Gartner estimated that employee turnover in 2022 was likely to increase by 20% from pre-pandemic averages. Meanwhile, a McKinsey & Co. study from last year showed that a lack of meaningful work and unrealistic performance expectations were two of the top four reasons that employees left their jobs.

Keeping employees may seem like an impossible task in these times, but a few key factors can significantly improve job satisfaction.

These include:

• Fulfillment. Everyone wants the feeling that their work has value. Work can’t feel trivial or redundant. It should feel like each step builds on the last to achieve something worthwhile.

• Employee support. Avoiding the dreaded burnout is more challenging than ever. Resources should be available for team members to reach out when they need help with their workload, mental health or education.

• Fair compensation. Employees want to feel appreciated and valued. This requires being paid a fair wage so they can focus each day on the work at hand without worrying about keeping up with the cost of living.

Benefits of technology

Mortgage company leaders are responsible for ensuring that team members get the support they need, otherwise they risk losing employees. The good news is that some of the best ways to reduce turnover can also benefit the business.

This includes embracing technology that enables employees to do their best work while contributing to the company’s broader goals. Giving team members the right tools can add to their job fulfillment and provide greater support, making them feel more secure in their positions and less likely to seek employment with another company. Plus, the right technology stack is especially helpful in allowing smaller teams to glean more value out of their daily work, then channel more of that value back into the company.

Noncritical tasks in the commercial mortgage space can bog down employees with trivialities, especially with fewer co-workers to provide support. For example, analysts or associates in the finance department often find themselves in the throes of compiling, reconciling and reformatting data across a variety of siloed sources as their chief value-add responsibility.

Rather than adding true value to deal diligence and analysis, much of their time is spent piled under disparate spreadsheets late into the night, duplicating data entries into a central location so that analysis can happen effectively. All of that manual heavy lifting can lead to a short shelf life for the rising talent in these institutions.

Deal management tools

Leaning on a comprehensive deal management tool can help teams avoid these taxing hurdles. Manual data reentry can be eliminated by migrating data from an Excel spreadsheet into a cloud-based solution, where it can be accessed for other processes. Employees can continue to use familiar software and entry systems while the company benefits from aggregated and tracked data.

The data, now easily accessible in a common format, can reduce processing delays, improve visibility into the risk associated with commercial real estate investments and help teams make smarter mortgage-related decisions. What’s more, centralized data can overhaul traditional approaches to ongoing asset and portfolio-level performance reporting.

Performance reports, quality assurance status reports and detailed credit memos are critical for intelligent commercial mortgage business management. But this type of work can take hours to complete. A technology solution can take these chunks of manual data triage and pull them together for teams of any size to effectively analyze.

Increase employee fulfillment

An investment in technology may seem like a counterintuitive move if you’re dealing with a tighter headcount, but keep the long-term savings in mind. The cost of employee turnover can be double the employee’s annual earnings, due to the time and labor involved in attracting, interviewing and training new personnel.

At a time when one-third of global real estate professionals are looking to cut costs, it’s more important than ever to slow the rate of turnover. Well-collected, well-stored and well-analyzed data can be the edge your company needs to retain staff and build value.

A deal management solution provides an opportunity for team members to continue using their existing data processes while eliminating data reentry and improving the usability of the data. By spending less time on data entry and analysis, team members can avoid frustration and burnout. They can instead focus on improving client relationships, creating new business for the organization and driving projects forward. ●

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In other words, borrowers need a hedge to protect themselves. In commercial real estate finance, interest rate caps and swaps are tools to mitigate the borrower’s risk. Mortgage brokers should be aware of the market factors that signal the need for hedging and understand why it’s a crucial strategy to manage exposure. They must be able to explain to their clients how methods such as caps and swaps work and offer tips for assembling a hedging plan.

“Conventional and natural hedging techniques include diversification of asset types, favoring equity over debt, timing the market for more favorable circumstances and betting on rent growth during times of inflation.”

Interest rates have increased as the Fed has tightened monetary policy over the past year. It was the most aggressive period of monetary tightening in more than 40 years, with a total of seven rate hikes, including four consecutive 75 basis-point increases. At the end of 2022, the federal funds rate stood at a target range of 4.25% to 4.5%. In February 2023, the Fed added an increase of 25 basis points, and the tightening is expected to continue but at a more gradual pace.

As rates have increased, so have lending costs and capitalization (cap) rates, which translate to higher risk. When financing costs and perceived risk increase, investors demand higher rates of return to offset the exposure. Consequently, as cap rates rise, valuations fall. And when the cost of borrowing exceeds the rate of return, negative leverage occurs.

According to research from Moody’s Analytics, 30% of commercial mortgage-backed securities loans exhibited negative leverage in third-quarter 2022 due to the rapidly rising costs of financing and relatively low cap (return) rates. Some borrowers are entering deals aware of negative leverage and hedging their bets on rent increases (a natural hedge). Their hope is that rising rents will gradually increase the net operating income (NOI) and rate of return to outpace the growth of debt service on floating-rate instruments.

With the current economic conditions, however, the degree of certainty that anyone can anticipate the market’s movements over the next several years is very low. Therefore, borrowers need additional interest rate hedging strategies to ensure long-term positive leverage, NOI growth and solvency.

Commercial real estate finance is inherently risky, yet experienced lenders, brokers and borrowers can prevail under most economic conditions with the appropriate tools. Hedging is a prudent strategy for many investments and is often lender required. When a broker’s clients are buying real property, hedges reduce the risk to individual assets and portfolios, as well as business and personal credit, by preparing for worst-case scenarios. Hedges essentially act as economic insurance.

Formulating strategy

It’s best to develop a hedging strategy early in the process of negotiating a deal because it is hard to switch course later. There are many variables and considerations in choosing a hedging strategy, so it’s best for investors to consult a qualified and experienced commercial mortgage originator and hedging advisor while in the planning stages.

Here are some reasons that borrowers and originators should consult a hedging advisor:

• Hedging approaches and products can be very complex.

• They’ll need help understanding the various documents and processes that are involved.

• Soliciting contract bids from multiple counterparties will result in the best execution.

Only the borrower, with the aid of their mortgage originator or hedging advisor, can make the call as to which hedging strategy is correct. Some combination of natural hedges and derivatives will work for most investors and their deals. Several variations of each derivative type are available, and one may best suit the borrower’s unique transaction and objectives.

Risk management

Conventional and natural hedging techniques include diversification of asset types, favoring equity over debt, timing the market for more favorable circumstances and betting on rent growth during times of inflation. With increasing costs of funds, raising as much equity as possible is sensible and sometimes necessary. Loan-to-value limits have tightened as lenders have become more conservative.

Borrowers also can delay development, acquisition or refinance plans until conditions are more favorable. These plans may not always be practical, however, if high expectations of growth and returns by investors demand action before economic factors are ideal. Moreover, the Fed isn’t likely to change direction anytime soon, so the grass may not be greener for years.

In the multifamily housing market, for example, rent growth has been a reliable hedge for commercial real estate owners as demand for units has caused valuations to soar. But with inflation restricting consumer and business budgets, and development activity catching up, rent growth has started to slow.

According to Realtor.com, U.S. apartment rents were up 3.4% year over year this past November, the smallest increase in 19 months and the 10th month in a row that annualized rent increases had slowed. Consequently, rising rents aren’t something that owners can count on to prevent negative leverage.

Use of caps

Each of the following approaches are valid, but the practicality and degree of protection offered by them may not be enough to make a deal feasible in an environment of rising rates and diminished returns. Property derivatives (which allow investors exposure to real estate by replacing the properties with the performance of a real estate return index) are an alternative solution to bridge the gap, preventing financial stress and default risk when rates rise. Caps and swaps also are used by creating a hedge through a derivative contract.

An interest rate cap is, fundamentally speaking, an insurance policy against rising interest rates. It is a limit on how high the interest rate can rise on variable-rate debt. It is tied to a short-term index such as the Secured Overnight Financing Rate (SOFR).

The interest rates on a large portion of commercial real estate loans are variable, so that when rates increase, so do debt-service payments and total financing costs (potentially pushing the asset or portfolio into negative-leverage territory). Rate caps create a ceiling that the interest rate cannot exceed. Once the interest rate exceeds this cap, the counterparty (a lender or a third-party hedge provider) will reimburse the borrower the difference between the current index or reference rate and the cap. The borrower still makes the principal and interest payments as stipulated by the original note on the asset.

To mitigate the risk of the rate rising above the cap, the counterparty requires a premium or upfront fee. In a rising rate environment, the cost of a rate cap can be high, but it is often well worth it to protect the solvency of the project. In summary, the primary advantage of an interest rate cap is that borrowers are shielded against substantial interest rate increases and can even benefit when rates fall. Conversely, the key disadvantage is that obtaining a cap agreement requires an upfront cost that can impinge liquidity at the outset of a deal.

Use of swaps

Another derivative instrument is a swap, which involves a derivative contract between the borrower and a counterparty to substitute a floating rate for a fixed reference rate during the term of the agreement. The swap rate is a fixed interest rate to be paid by the borrower.

In this arrangement, the counterparty will pay the floating rate to the borrower and the borrower will pass this onto the lender. The borrower will then pay the fixed rate to the counterparty. The counterparty adds its premium into the rate so that the borrower pays it over the life of the swap contract. The borrower does not pay an upfront premium, but depending on the relationship with the counterparty, the borrower often must post collateral.

The borrower will benefit when floating rates rise above the fixed rate, but they may lament entering the swap agreement if rates decline. To ensure the borrower continues to honor the contract, they typically must pledge collateral. If the borrower chooses not to uphold the swap, the counterparty can claim default and require a termination or buyout, and breakage or prepayment penalties will be due.

Swaps offer an alternative approach to interest rate risk protection with no upfront costs, allowing investors to conserve cash and move forward with confidence. The primary downside is that swaps are less flexible if the borrower opts to make an early exit from the asset or note, often as a response to declining rates.

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With an awareness of the capital markets, monetary policy and finance hedging techniques, borrowers and originators can confidently proceed with transactions. When a deal initially looks like the numbers don’t make sense, dig into due diligence, do what’s possible to raise additional equity, and research the available hedging techniques and products. This will provide a solution that brings economic risk to manageable levels and magnifies the upside for all parties to the transaction. ●

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