The government-sponsored enterprises, Freddie Mac and Fannie Mae, have triggered an increased number of buybacks this year as they process the loans sold during and after the pandemic-initiated purchase and refinance boom. The timing couldn’t be worse, with these extra expenses coming while lenders’ pockets are already thin. Too many repurchases can spell disaster, especially for smaller lenders. But this impact isn’t felt only at the corporate level — these buybacks impact individual originators too.

“When any lender puts credit restrictions onto their business model, it is the least represented borrower that first gets impacted.”

Taylor Stork, president, Community Home Lenders of America

If you’ve noticed increased calls from confused former clients, you’re not alone, says Taylor Stork, a longtime originator and president of the Community Home Lenders of America (CHLA). When a loan is repurchased, it changes hands at least once, if not twice, and usually changes servicers. This triggers a flood of “hello” and “goodbye” letters to the borrower, who is likely to call their mortgage originator for help figuring out where to send payments.

As the originator, you’re unlikely to know what’s going on and will have to dig for information. If you’re a broker, Stork says, it’s likely you won’t be able to get any information at all, since you’re not privy to the transaction and it’s protected by information security rules.

“(Clients) expect me to make sure that they are taken care of all the way through the process,” Stork says. “For originators, it creates a tremendous amount of confusion. It certainly tarnishes the relationship that we have with our customers and with our referral sources.”

There’s an impact on the originator even before the buyback happens, says Brendan McKay, president of advocacy for the Association of Independent Mortgage Experts (AIME). Before a buyback goes through, the loan is audited. This often means requests to the originator for additional documents from the borrower, sometimes months or years after closing.

The GSEs argue that these loans don’t meet their quality standards, with Freddie Mac citing miscalculated income and missing documents as the two leading causes of buybacks. But lenders and mortgage advocacy organizations argue that many are returned to the lender for minor issues on loans that are still performing well. “These are not bad loans,” Stork says. “These are good loans that may have little, tiny technical errors.”

Often, the repurchase request is not even due to error. “A lot of these, as we’ve gone through them, have been [due to] appraisals,” says Scott Olson, CHLA’s executive director. “People had two appraisals. They both are fine and (the GSEs) are claiming, ‘No, we disagree.’ … It’s just a difference in judgment.”

A lender being forced to take back a performing loan may not seem like a dangerous prospect, but lenders often aren’t equipped to hold loans on their balance sheets. This means they must resell the loan after the buyback, and most lenders turn to what McKay terms the “scratch and dent” market to do so. Loans sold this way incur massive losses for the lender. And this puts smaller lenders at higher risk of default since the losses on only a few buybacks can make a huge difference on their balance sheets. “Getting a loan bought back is absolute misery,” McKay says.

These costs averaged 8 basis points per loan in 2020 before rising to 68 bps in 2023, according to McKay. “That cost, if it continues, is getting passed along to the loan officer and the consumer,” he says. “All of us are going to have worse rates. That’s why originators should care about this.”

Stork says the natural response by lenders and originators is to tighten qualification standards in an attempt to bulletproof the loans and prevent them from being bought back. “When any lender puts credit restrictions onto their business model, it is the least represented borrower that first gets impacted,” he says. “Buybacks result in a tightening of the credit box.”

This past October, the Federal Housing Finance Agency (FHFA) tweaked its buyback policy for loans subject to COVID-19 forbearance. It also reported that GSE repurchase requests have passed their peak, with buybacks now trending downward. But there’s still work to be done.

The CHLA has called for the ceasing of all pandemic-era repurchase requests that aren’t tied to fraud, if the borrower is current on their payments. AIME has called for refinement of the buyback policy, as well as increased transparency and consistency around its enforcement. The FHFA said in October that the GSEs must implement a “fair, consistent and predictable process.” The eventual goal is to create less ambiguity in underwriting, which should reduce buybacks in the long term.

Buybacks are important for originators to understand because they’re on the frontlines and are likely to deal with the fallout. These include a tighter credit box, loan audits and more document requests. In the most dire circumstances, lenders could lay off staff or fold.

“They need to understand their responsibility in helping to protect the industry, whether for everyone’s good or their own good,” McKay says. “This type of pain doesn’t exist in a vacuum. It’s going to get shared by everybody.” ●

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Billed by the FHFA as a way to promote competition between credit bureaus and reduce lender credit reporting costs (and pass the savings to borrowers), TransUnion claims that the biggest impact would be two million consumers becoming ineligible for a mortgage backed by Fannie Mae or Freddie Mac.

That ineligibility, per TransUnion, would stem from gaps that can exist among lenders when it comes to reporting a complete credit picture, particularly if a potential borrower’s most favorable set of credit data comes from the bureau that would get excluded in the bi-merge.

The shift could also end up costing consumers more than it saves, with 600,000 new borrowers every year paying more in interest due to an incomplete credit picture being used for underwriting. Per borrower, it could cost $6,600 in additional interest over the life of a loan, according to TransUnion.

“Under a bi-merge, first-time homebuyers who have thin files or are new to credit could become unscorable or, if they are scored at all, could be charged a higher interest rate than they would otherwise,” said Joe Mellman, senior vice president and mortgage business leader at TransUnion. “Just one missing tradeline that may result from using one less credit report could dramatically impact eligibility and monthly payments. Ultimately, the decision to only use two credit reports could make all the difference in whether an interested homebuyer is able to buy a home or not.”

Most likely to feel the impact in such a situation are low- and moderate-income earners, as well as many first-time buyers. Additionally, there could be unforeseen negative impacts on mortgage equity, as Black and Hispanic borrowers comprise a large part of the cross-section of potential borrowers with credit scores around 620, nearing the eligibility threshold for a government-sponsored enterprise mortgage.

Moreover, TransUnion asserts that, on top of disqualifying potentially creditworthy borrowers, the reverse could also come to pass: an inaccurate picture of otherwise ineligible borrowers could result in more unqualified approvals, potentially raising the risk of default. The company estimates that 200,000 applicants who would be turned down for an agency mortgage under the tri-merge would be able to borrow under the bi-merge plan. Incomplete information could also result in some borrowers paying less interest than merited by their true risk picture, depriving Fannie and Freddie of some $4 billion in risk-based fees.

“By intentionally bypassing vital consumer credit information from the third credit bureau, the proposed changes could result in miscalculated consumer affordability and risk,” said Jason Laky, executive vice president and head of U.S. financial services. “As a result, many consumers will be given mortgages that they cannot afford or at higher cost. We’ve seen the devastating effect that had on homeowners during the Great Recession.”

“Not only will consumers save less than one fifth of one percent of mortgage origination costs by not paying for complete data,” added Mellman, “but mortgages could ultimately become more expensive if investors demand higher premiums to compensate for additional risks, vendors charge more to make up for a complex transition, and lenders charge more to recoup additional legal, compliance, and regulatory oversight needed.”

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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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While inflation may be abating, the capital markets are in a period of discovery. Many commercial mortgage lenders have significantly pulled back in the wake of the Silicon Valley Bank, First Republic Bank and Signature Bank failures earlier this year. What made these collapses unique was the speed at which their deposit runs occurred. Now, unsurprisingly, there are growing concerns from regulators that are exploring new and better ways of monitoring lender balance sheets and liquidity.

As an example, the Fed is now considering the implementation of “reverse stress testing.” This approach would evaluate the conditions needed to break a financial institution, rather than creating an artificial stress scenario and its projected impact. Institutions with assets of $100 billion or more already receive more scrutiny and are under more regulatory obligations at the federal level. While these banks tend to make the most loans tied to commercial real estate, they also have fewer effective options for loan risk management or balance-sheet optimization. Recently, many of these lenders have looked to the insurance industry for a possible solution.

Similar in concept to private mortgage insurance on residential loans to consumers, commercial property loan insurance (CPLI) is an investment grade-rated loan guarantee product designed to serve as an effective risk transfer and mitigation strategy. By leveraging this option to insure the most risky portion of a commercial mortgage, lenders can gain significantly better access to liquidity, balance-sheet optimization and risk management when financing a real estate project. It’s something that mortgage brokers and borrowers should understand as they work with lenders to structure safe and cost-effective financing.

Prudent approach

The Federal Reserve requires banks with more than $250 billion in assets to be stress tested each year. (Institutions with at least $100 billion in assets are evaluated in even-numbered years.) Importantly, these rules now cover a large portion of prime commercial real estate lenders.

The enhanced scrutiny impacts these institutions’ balance sheets and liquidity. Although a lender could possibly raise more debt or equity to address this, doing so is expensive and dilutive. Another option is to curtail commercial real estate lending activities, and many institutions have already met (or are exceeding) their concentration limits, meaning that they’ll receive additional regulatory scrutiny. Many lenders are even selling their commercial mortgage notes, especially for certain office and retail properties, at significant discounts.

Regardless of size, focus or geography, all commercial real estate lenders need to ensure they are employing best practices when it comes to risk management. The recent and relatively quick collapses of the three previously respected banks are harsh reminders of what can happen if these measures fall short.

Constant due diligence is a requirement for all types of risk — and not only for an institution’s loan exposure. The banks that failed this year had some things in common: Their loan portfolios were reasonably solid and up to date, but they improperly managed interest rate and deposit risks. These events also serve as reminders that the industry-ingrained stance of “waiting until others go first” has proven to be a faulty if not fatal approach.

Insurance basics

The unexpected deposit runs and rapid interest rate increases that felled these banks can have significant impacts on any lender’s balance sheet. In addition to liquidity issues, these can also affect capital requirements, concentration levels and loan-to-value regulatory parameters, which can put an institution at risk by severely hindering its operations and profitability.

Just as regulators are exploring new methods of stress testing, many commercial real estate lenders are seeking new approaches to optimize their balance sheets. Commercial property loan insurance has emerged an alternative. Other available options (including credit-linked notes, credit-risk transfers and credit derivatives) tend to offer mixed success at best, since they can be costly or unreliable.

There are two main strategies for lenders to employ in regard to CPLI. It can be used alone or in conjunction with a fixed-income collateral agreement. Either of these strategies can be highly scalable. Commercial mortgage lenders can quickly compare these paths by identifying the risk weighting for a specific loan amount, then reviewing the costs of each option using market percentages of first-loss protection.

For example, on a loan pool of $1.13 billion with a conservative overnight rate and spread of 12.5%, the cost to leverage loan insurance (with or without a collateral agreement) can be roughly 40% to 60% lower than using credit-linked notes or credit-risk transfers. This also provides more capital, operational efficiency and scalability for the lender.

Using CPLI on its own is an effective option, but commercial real estate lenders can also leverage it in conjunction with additional cash, or cash-equivalent collateral, for added risk-weighted benefits. Regulators are likely to view this collateral as having a zero risk weighting, which means a much lower impact on a lender’s overall capital requirements — and likely its concentration requirements.

Creating an agreement for pledged collateral that serves as a credit enhancement for a commercial mortgage is a fairly straightforward process, with the collateral remaining liquid and held in an escrow or equivalent custodial account. An investment grade-rated CPLI policy would then be purchased, either by the lender or the borrower, to remove the need for a personal guarantee. This places the insurer in the first-loss position ahead of other parties while protecting the collateral at hand.

Urgent action

This year’s bank collapses gave all lenders a sobering reminder of the consequences of a risk management failure. These events not only highlighted how difficult it can be to predict and plan for unexpected events — the purpose of any insurance product — but more importantly, why adhering to the status quo related to due-diligence strategies could be a costly or fatal move.

Banks are likely to be further scrutinized in the months ahead. As regulators broaden their methods of assessment, the commercial mortgage lenders that have traditionally taken a wait-and-see approach may quickly find themselves in a difficult position.

Additionally, as underwriting continues to be impacted by current pre-recessionary market conditions, and as nonbank lenders rush to fill the gaps left by many banks moving away from commercial real estate, the cost of borrowing is likely to continue to rise. Lenders that start to explore their options now rather than waiting until they are forced to react are likely to increase their risk mitigation capabilities. They could capture a significant competitive advantage in the marketplace or possibly even regain lost market share.

● ● ●

With commercial mortgages representing the largest portion of assets in the portfolios of many community and regional lenders, the impact of failing to act could be devastating. As other areas of the capital markets explore alternatives to optimize balance sheets and lessen risk, the implementation of commercial property loan insurance can offer lenders an immediate and cost-effective solution. This can provide the regulatory relief and better risk management they need to thrive, regardless of anticipated market cycles or unexpected events. ●

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One in five Gen Zers were having their on-time rent payments reported to the credit bureaus, according to a TransUnion survey released this past June. And 86% of the respondents in this age group reportedly saw their credit scores improve. The survey conducted in March 2023 included responses from roughly 150 property managers and 3,300 renters.

Gen Zers have their rent payments reported at double the rate of the population as a whole — 21% compared with 11%, according to the survey. Gen Z appears more financially aware and more focused on improving their credit than prior generations, says Maitri Johnson, TransUnion’s vice president of tenant and employment. “For example, other TransUnion research has found younger generations are more likely to use airline and hotel memberships and affiliated rewards credit cards to maximize their spending,” Johnson wrote in an email.

“Like 10 years ago, I remember us having conversations around how to expand credit to those with thin credit files by looking at their rent payments.”

– Kristin Messerli, co-founder and executive director, FirstHome IQ

Property managers are also increasingly likely to report rent payments, with nearly half of those who do having started in 2022. The most common reasons cited were to help tenants build their credit scores and to encourage residents to pay on time.

There are more financial literacy options today than there were for previous generations, says Kristin Messerli, co-founder and executive director of FirstHome IQ, a nonprofit that offers homeownership education. Gen Zers rely less on information from loan officers and more on financial education via social media, she says.

“I think we’ve moved away from trusting institutions and more toward trusting individuals,” Messerli says. “It’s not to say that they are trusting everyone they see on TikTok, but they’re capturing information and they’re getting information that otherwise wouldn’t have been available to them.”

On-time rent payments help younger and more diverse borrowers build credit faster, Messerli says. And this has become part of a national conversation. “We’ve been talking about this for many years,” she says. “Like 10 years ago, I remember us having conversations around how to expand credit to those with thin credit files by looking at their rent payments.”

In 2021, Fannie Mae and Freddie Mac each launched programs aimed at using rent payments in the mortgage approval decisionmaking process. Last year, all of the major credit bureaus (Experian, Equifax and TransUnion) started to include rent payments in credit reports and credit-score calculations.

“It’s difficult to say why it didn’t happen earlier, but the call to make it a standard practice has steadily built momentum over the past several years,” Johnson says. “I think the reason it gained traction so quickly is due to the fact that consumers and the financial services industry are both pushing for residents to get credit for their consistent on-time rent payments, along with other regular payments like utilities and telecommunications.”

Still, even those who are making gains on their credit scores face a tough road, says Jonathan Lawless, head of homeownership at Bilt Rewards, a loyalty points program. His company works with 40 major multifamily property owners in the U.S. and allows renters to earn rewards points for their rent payments, with no transaction fees, while building a path toward homeownership. Bilt offers a co-branded credit card as well.

There are 24 million renters in the U.S. between the ages of 30 to 44, which can be considered prime homebuying years. But there are only about 600,000 homes actively listed for sale at any given time, Lawless says. The lack of supply remains a major stumbling block even for those who are improving their credit scores.

“It basically means that unless you’re sort of in that top 10% of income earners or savers in the rental class, you really don’t have a shot at those limited number of listings,” says Lawless, who also points to affordability and wage growth challenges.

Renters tend to be younger, and a meaningful percentage don’t see more than a 10- to 15-point improvement in their credit scores via on-time rent payments, Lawless says. But it will turn credit invisibles — consumers with limited or no credit history — into credit visibles. And the major credit models consider the age of credit. The more seasoned the credit, the better the score, he says.

“It is very important to have that awareness and to start early,” Lawless says. “The first thing you do out of college might be to start renting an apartment and, boom, suddenly you’ve got a credit score.”

Credit-score improvement can thus pay dividends for those on the cusp of purchasing a home now. And it can also help younger consumers get on the right path so that when market conditions change in the future, they’ll be well positioned to buy.

“Let’s get them on the right journey,” Lawless says. “Let’s educate them. If they can’t find the right home now, keep building their credit so when they do find the right home, they’ve got the best possible chance.” ●

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The actual numbers are even more disconcerting. The average time to process a loan application remains at 45 to 60 days, according to ICE Mortgage Technology. And a recent Mortgage Bankers Association reported that the net loss per loan for independent mortgage banks jumped from $82 per file in second-quarter 2022 to $2,812 per file in Q4 2022.

It is often believed that inefficiencies in underwriting are the primary causes of extended lending timelines, increased operational expenses and a disappointing borrower experience. But it is essential to examine other aspects of the loan origination process to more accurately pinpoint the causes of inefficiencies. Various lenders and underwriters across the industry report that the actual problem lies in the processing stage, which leads to inefficiencies in underwriting.

Processing bottleneck

A high volume of loan applications, coupled with outdated document processing systems, causes a bottleneck. As a result, the loan applications emerging from the processing stage contain inaccurate information, missing data and sometimes even missing documents.

Every underwriter is expected to strike a delicate balance between avoiding the approval of high-risk loans and meeting their monthly performance targets. When inaccurate or incomplete applications end up on an underwriter’s desk, they are left with no choice but to manually go through all the documents to make sure the borrower is eligible for a loan. Underwriters often find themselves having to contact borrowers or originators to obtain the missing information, which is an incredibly frustrating and time-consuming process.

In other words, the output from the processing stage slows down the underwriters, and not the other way around. The ideal solution to this problem is to implement straight-through processing. This would automate the entire lending life cycle, from collection of loan applications and documents to disbursement of the loan, with little to no manual intervention.

But it’s not as easy as it sounds. The mortgage industry must go through various stages of maturity in terms of technology, data purity and process refinement to achieve straight-through processing.

Lending maturity

The maturation of the mortgage industry can be classified into five stages. The first stage is business process outsourcing, where the verification of loan documents is outsourced to third-party companies. The process is resource intensive, slow and prone to errors.

Stage two is logic-based automation. This involves software tools that focus on automating one part of the origination process — the collection of loan applications. It increases the number of loan applications received at the front end but adds a significant amount of stress to other stages of the origination process.

The third stage is the “intelligence layer,” or the use of artificial intelligence (AI) and machine learning technologies to transform the processing layer of the loan origination process and provide contextual insights on a borrower’s creditworthiness. This saves underwriters a lot of time by surfacing critical insights to help them make informed decisions.

The fourth stage is next-generation intelligence, where collected data is automatically cross-verified with multiple third-party services to automatically make informed decisions. The fifth and final stage is straight-through processing, a touchless loan origination system where an application is automatically processed from end to end.

Where we are

Today’s mortgage lenders are largely at stage two. They’ve automated front-office operations to facilitate the touchless collection of loan applications and documents, but they haven’t made much progress in the processing and underwriting stages of the origination process.

There are tools in the market that promise touchless automation without human intervention, but they haven’t accounted for the data problem. Completely touchless automation is not possible until clean data is available to mortgage professionals.

But the mortgage industry can bring significant improvements to the processing stage of the origination process thanks to technologies like AI and machine learning. There are three essential areas where these technologies will play a major role in improving the lending process.

How it could work

Automating the analysis of borrower bank statements with AI and machine learning technologies will help in getting cleanly processed data early in the origination process. The analysis technology should look for suspicious transactions, classify them into various categories and look for discrepancies. By moving these preliminary judgments upstream, the load can be lessened on the processing and underwriting stages.

The analyzed information should still be verified by a human underwriter. But by presenting pre-processed, contextualized information in an easily digestible format, underwriters can be given all the information needed to quickly make a wise lending decision. This can be achieved with the right blend of technology and user experience design, which will make it easy for an underwriter to use the software.

Considering the current level of data purity, it’s certain that companies won’t get 100% pure data from their borrowers. There will always be documents that are not readable or have missing fields. The industry needs an automated workflow that automatically pushes incomplete documents from the AI-powered bank-statement analyzer to a team of experts for human verification.

This will speed up the entire process, as good applications will go to the cross-verification stage after the analysis and only the applications with missing data will be sent for human intervention. Building the aforementioned components into a tech solution will help mortgage lenders shorten processing times, lift the burden off underwriters and improve their productivity while providing the best borrower experience. ●

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The questions asked, the degree of investigation and the depth of analysis conducted during the underwriting process may generate millions of dollars in revenue or millions of dollars in potential losses for the lending institution at hand. Commercial real estate is a costly investment, making an appropriate level of investigation crucial for the investor and the lender. Aggressive due diligence requires the buyer to spend time inspecting the subject property to mitigate the financial risks associated with the investment.

Objective opinion

Aside from the seller’s disclosure of relevant issues, the responsibility is on the buyer to find any unidentified material issues that could influence the asset value and the ultimate closing of the transaction. Commercial mortgage companies often collaborate with counterparties, vendors, supply chains and technology systems, which can be vital in the risk-analysis process. Statements generated from entities unrelated to the transaction are frequently referred to as third-party reports. An impartial third party is usually a necessity for a successful transaction.

“Typically, title insurance is mandated by banking regulators and it is a requirement if the loan is sold to investors on the secondary market.”

A third-party report can be any study, investigation or other information compiled for the buyer or seller by a professional advisor who offers an objective opinion about the property. These reports protect all parties from making a poor investment decision. Lenders also rely on third-party reports to disclose all material information about the property.

The subject reports are varied in nature, require time to develop and can be costly. If they’re needed, they should be ordered as soon as possible. Mortgage brokers of all experience levels know that commercial real estate transactions are like snowflakes. Some deals may not require each of the third-party reports discussed here, while others may require additional investigation or unique iterations of these reports. Commercial mortgage lending is never a cookie- cutter process.

Appraisal and title

An appraisal is an opinion of value that derives the required equity contribution, loan-to-value ratio and approval of the loan. Banks that are supervised by the Federal Deposit Insurance Corp. (FDIC) are required to have procedures for selecting appraisers, as well as techniques for monitoring appraiser performance. In 2018, the FDIC created a new threshold and began exempting commercial real estate transactions of less than $500,000 from its appraisal requirement.

The appraisal process is driven by the Uniform Standards of Professional Appraisal Practice (USPAP). The purpose of USPAP is to provide guidance for developing and reporting appraisals, and its key provision is to assure independence and competency.

The most commonly used appraisal method in commercial real estate is the income approach, which bases the asset’s value on the income it generates. If the appraiser does not see the value the investor expects, the deal may fall apart. Generally, the investor will have their own perception of value, but they must be ready to support their opinion in quantitative fashion. A commercial mortgage broker should be proactive and provide the lender with as much information as possible to support the value.

Title insurance, meanwhile, is adaptable to meet the needs of a specific deal and will protect parties from issues with the chain of title to the subject property. There are two types of policies offered by title insurance companies. One is the lender’s policy, which protects the lender if there is a problem with the title. The other is the owner’s policy, which protects the buyer if issues are discovered.

A title company will conduct a deep dive into all recorded assignments, encumbrances or other liens that may have been filed against the property. The search concludes with a preliminary title report for the lender. Typically, title insurance is mandated by banking regulators and it is a requirement if the loan is sold to investors on the secondary market.

A title insurance company also may offer various policy endorsements, which protect against more than the standard title problems. There are about 100 different endorsement options that can cover such things as zoning conflicts, boundary errors and environmental concerns.

Surveys and conditions

A land survey is used to identify the existing attributes of a property. These include boundaries, rights of ways, structures, easements, encroachments, water features and other significant characteristics of the property.

A survey will establish the boundary based on the title commitment’s legal description, and it should identify any discrepancies between the existing description and the survey. The survey also will depict how survey-related exceptions to title affect the property. These are items that the title insurance will not cover and are normally found in Schedule B of the preliminary title policy. Circumstances dictate the need for a land survey. For example, if the lot is part of an existing subdivision, the survey requirements will have been previously met.

But if the transaction involves the purchase of raw land or the consolidation of two parcels, a survey will be required by regulators and secondary market investors.

A property conditions report is designed to identify issues with the asset’s physical condition. It may include an inspection of major building components such as heating and cooling systems, fire suppression systems, elevators, roofs, asphalt or sewer lines. The report will provide an estimated useful life for these items.

The use of this report is a frequent best practice for a lender, and it is often based on the size and complexity of the deal. It gives the buyer and lender a second opinion on the condition of the property, and it can confirm inspections completed earlier in the purchase process. The report is designed to be unbiased, giving the investor more credibility and negotiating power while helping to mitigate any lender concerns.

Lenders and regulators will have well-defined policies and procedures for environmental due-diligence tasks. If any level of potential contamination is suspected, an Environmental Site Assessment (ESA) report will look into soil composition, hazardous materials and other suspicious-looking features on the property.

Typically, this process includes a lender checklist, a public domain records search, and a Phase I or Phase II ESA report. If contamination is found, a costly and time-consuming cleanup process must take place, which may well kill the lender’s interest in the deal. Another aspect of environmental due diligence is a complete visual evaluation of all accessible areas of the property for the presence of asbestos and lead-based paint.

In addition, a seismic report may be required in certain states. This assessment will examine all structures to make sure they comply with procedures outlined by the American Society of Civil Engineers.

Market studies and more

A market study will take an in-depth look at the various economic aspects of an investment property. Specifically, it will look at supply and demand in the local market, and it will determine whether the property’s net operating income is likely to grow or shrink over time.

This study is optional and will depend upon the nature of the project. If the venture is unique (e.g., a hotel, golf course or another one-off project), the investor may need a formal market study to confirm their ideas and move the concept forward with other stakeholders. Market reports are generally expensive but usually worth every penny. They can be used to support investment assumptions such as absorption rates, rents and net operating incomes.

Zoning is a structure of legal codes used to develop various parts of a city or county, and it includes different requirements and constraints. The purpose of zoning is to protect existing neighborhoods. A zoning compliance report is a description of the zoning conditions and is often a necessary component of the acquisition process for developers, investors and lenders. In other words, it is an optional but common best practice. In the worst-case scenario, a serious code violation could impede or destroy a transaction. Escrow services are yet another option to consider. Real estate escrow companies act as neutral third parties to hold various deeds, documents and funds involved in the completion of the transaction. An agent deposits funds into an account on behalf of the buyer or seller. An escrow official will obey the directions of the lender, buyer or seller in a prescribed manner when managing the funds and documentation associated with the sale. ●

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Prudent mortgage originators need to analyze all GSE programs to decide which option is right for each client based on which program can offer the best terms for a particular investment deal.

Government created

Freddie Mac options

Fannie Mae role

Making a choice

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Institutional control

The truth is, institutional capital drives the cost of lending for everyone, regardless of whether they use the institutional method of funding or not.

Plugged in

Changing language

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Collect wisely

Silo obstructions

Targeted tools

Simple and practical

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