Rob Diodato, Author at Scotsman Guide

A Continuing Rough Ride

Rob Diodato — Tue, 31 Oct 2023 21:19:51 +0000

At the start of this year, it was widely predicted that 2023 would bring more turbulence to the commercial real estate market. And many of the difficulties discussed then have played out exactly as expected.

The Federal Reserve has continued with its mandate to curb inflation by raising benchmark interest rates. While data reflects that this policy has certainly contributed to the general downtrend in inflation throughout the year, the impact on commercial real estate has been dramatic and not so positive.

“It is difficult to be optimistic about the remainder of 2023 or the early days of 2024.”

This year will prove to be one of the more challenging in recent memory for commercial mortgage originators. At this point, the outlook for 2024 does not appear markedly different as the sector manages the higher interest rate environment, which will potentially result in a rash of loan defaults and modifications.

Myriad troubles

In the residential real estate sector, limited housing supply has contributed to elevated prices despite a higher interest rate environment. Conversely, the commercial property sector this year saw asset values and loan origination activity plummet across all segments. Office and retail have suffered the most as lenders pull back from these areas.

Coupled with a higher interest rate environment, the market dealt with a short-lived banking crisis that ended before it even started. Sure, some banks dissolved due to a series of problems, including mismanagement and a flight of deposits. But there were others, including the nation’s largest banks, that weathered the storm and became even stronger.

The calendar years of 2021 and 2022 were generally ones of prosperity in both the commercial and residential sectors, fueled by low rates and insatiable demand. But as Warren Buffett was famously quoted as saying, “You don’t find out who’s been swimming naked until the tide goes out.” Many banks did not sufficiently hedge their Treasury portfolios, leaving them exposed to higher Treasury rates.

A number of vertically integrated real estate companies also found themselves holding high-rate bridge or construction debt, and they had no true exit strategy as a result of higher rates hampering their debt-service-coverage ratios. Couple that with higher property taxes and exponential increases in property insurance, and you have a perfect storm for which there is no port.

Many lenders, originators, developers and operators have entered the market over the past decade. A portion of these newcomers thrived due to timing rather than knowledge or skill. But times have changed and many areas of the commercial real estate business have dried up. As an old saying goes, “When fish are swimming into the net, you are not truly a fisherman. It is when they don’t that you learn whether you are.” Many of these novices have found this year that they are not truly fishermen. Deals have not only been harder to come by but harder to qualify and close.

Dark outlook

It is difficult to be optimistic about the remainder of 2023 or the early days of 2024. The Federal Open Market Committee (FOMC) has stated that it will keep interest rates higher for longer to curb inflation. While the FOMC may not raise rates further, borrowing costs are likely to remain elevated for some time. This climate will restrict lending volumes for commercial real estate as deals will continue to be debt-service constrained, limiting proceeds.

There are also growing concerns about inflation in wages and services, which may push any rate-cut projections further into the future. Another major fear is that a wave of new multifamily properties set to be delivered will drag down rents and curb construction in this sector. In addition, increased costs for energy, labor and materials could add to the woes of multifamily operators as they move forward.

Nearly $700 billion in short-term, low-rate loans on multifamily housing are expected to mature in the next two years, and many of these will have problems being refinanced. The near future also will bring defaults for office properties in many major markets. But as more companies require workers to come back to their cubicles, there is hope that the office sector will make a comeback.

Another area that reaped a post-pandemic boost in demand was the industrial sector, although signs of softness have started to emerge. And hospitality, a sector that sees lender interest vary, is on the tail end of an upturn since the lifting of pandemic-era restrictions. Recently, the appetite for hotel lending has begun to wane.

Glimmers of hope

One area of commercial real estate that may show continued strength is owner-occupied loans. Lenders are aggressively pursuing such deals, as well as the potential depository relationships afforded by these business clients.

Lenders also prefer using the U.S. Small Business Administration (SBA) platform to facilitate these owner-occupied deals, offsetting risk and exposure. Additionally, the secondary market for SBA 7(a) loans remain robust and represents a far more profitable transaction to lenders — with a fraction of the risk.

Although it seems unlikely that lending volumes will increase soon, there are reasons for optimism due to the fact that virtually every deal financed during this period of higher interest rates presents a refinance opportunity down the road. This is because any deals closed today are, in essence, bridge loans of sorts as borrowers wait for rates to fall.

As a rule of thumb, it is best to limit prepayment penalties on any newly financed transactions. Mortgage brokers should also avoid any defeasance, rate-swap or yield-maintenance transactions so that when rates do come down a bit, borrowers have no restrictions that prohibit them from refinancing and taking advantage of better terms.

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As any loan originator will tell you, 2023 has been a difficult year. And unfortunately, 2024 doesn’t look to be much better. The key to surviving this period will be persistence and a focus on the segments of the market where financing remains readily available, such as multifamily housing and SBA loans for owner-occupied deals.

Using these tools should help you set the table for what will likely prove to be a more opportunistic time once the Federal Reserve has reversed course on its cycle of rate hikes. This will be a testament to Darwinism: Only the strong will survive, and those without the fortitude, experience and ability to excel in a down cycle may find themselves in another field. ●

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More Turbulence Ahead

Rob Diodato — Sun, 01 Jan 2023 09:00:00 +0000

As 2022 comes to a close and all eyes turn toward the new year, the commercial real estate market remains in flux. Interest rates continue to rise as the Federal Reserve pushes forward with its agenda to curb inflation. This past November, the Fed completed a fourth consecutive hike of 75 basis points, pushing the federal funds rate to a range of 3.75% to 4%, its highest level since 2008.

There is no definitive end to the current cycle of increases. How this policy will impact the U.S. economy going forward is one of the major issues that members of the commercial mortgage industry will have to decipher as they make plans for running their businesses in 2023.

Fed Chair Jerome Powell is following in the footsteps of one of his predecessors, Paul Volcker. For those unfamiliar with Volcker, he led the Fed’s board of governors from 1979 to 1987 and successfully reduced inflation from a peak of 14.8% in 1980 to less than 3% by 1983.

This reduction, however, didn’t come without pain to the national economy. Volcker raised the federal funds rate from an average of 11.2% in 1979 to 20% by June 1981, with the prime rate peaking at 21.5% during this period. This led to a pair of recessions from 1980 to 1982 and an unemployment rate in excess of 10%.

Although Volcker was widely criticized at the time for his stance to combat inflation, he was widely heralded as the shepherd of a booming economy that resulted from his policy decisions in the coming years. It appears that Powell is looking to mirror the dramatic and controversial tactics of Volcker in the near future, with the hope that inflation will be quashed and long-term economic growth will follow.

Whether this is the right path will be a debate for historians down the road. The resulting impacts, however, will continue to be dramatic for the commercial and residential real estate finance industries in 2023. The pressure on the real estate sector will continue until the Fed chooses to reverse course.

The Fed’s mistake

The year 2021 was a boon for commercial and residential real estate. A low interest rate environment led to strong demand in both sectors, despite the lingering COVID-19 pandemic. Last year started off in the same manner until prices began to rise quickly. What Powell first deemed to be “transitory” inflation was later determined to be a far bigger problem.

Inflation is an increase in the prices of goods and services. If supply cannot meet demand, prices rise. If supply is suppressed, such as in the case of the pandemic-related supply chain issues, prices rise. If supply is delayed or costs more to ship, prices rise. All of these, in one way or another, have contributed to a 40-year peak in the U.S. inflation rate.

The mischaracterization of inflation put the Fed in the position of playing catch-up after the first quarter of 2022, leading to a series of unprecedented rate hikes that shook the markets. Quite simply, the Fed got it wrong initially. Officials then had to impose larger rate hikes more quickly than the markets could contend with.

The goal of these rate hikes was to curb demand and reduce the costs of food, gas, rent and other essential expenses. But the negative effects on the real estate sectors are a byproduct of these policies. There’s an argument that the “blunt instrument” of rate increases is as destructive as it is warranted.

Depressed markets

Even though much of the pandemic- related supply chain issues have dissipated, the effects on pricing have remained. Economics 101 teaches that the simple answer to offset price increases is to ramp up supply in order to stabilize prices. But that is not necessarily in the best interests of for-profit companies, and they will hold out until consumers push back.

Commercial mortgages are priced using an index (such as the prime rate or U.S. Treasury) plus a margin. The lender chooses the index and determines the margin. Once these indexes rise, commercial mortgage rates rise along with them. In turn, this has an impact on cash flows, net operating incomes and debt-service-coverage ratios, resulting in fewer deals being approved and fewer investors willing to enter the market. It also increases capitalization rates and results in lower prices.

In the residential housing sector, Powell has made his belief clear that the market was overheated — that supply and demand needed to become more balanced, as opposed to the frenetic demand that greatly outstripped supply early in the pandemic. Demand for owner-occupied housing has waned, but prices remain elevated in certain pockets of the market.

In the commercial real estate sector, rising rents (a core component of the consumer price index) are benefiting multifamily owners. Hospitality assets also continue to flourish as pent-up demand created by the pandemic has led to travel-related sectors (including airlines) reaping the benefits. Travel activity has largely returned to pre-pandemic levels.

The office sector suffered early in the pandemic as many companies shifted to a remote-work environment. While this shift started to reverse in the second half of 2022, the fact that companies are now laying off employees could result in a backward step for office owners. Expect landlords to offer rent concessions to offset any decrease in demand. This may include steeper decreases for Class B and C properties when compared to Class A properties.

Looming layoffs?

How will all of this continue to play out in 2023? Making projections on the economy and its impact on real estate is difficult. As the old joke goes, if you get five economists in a room to predict the future, you will get seven different opinions.

It appears that rates will rise modestly in early 2023. Demand for commercial real estate will remain depressed as inflation lingers and the Fed stays on its current course. While rates will stay high to combat inflation (which will continue to dampen demand across the residential and commercial real estate sectors), the multifamily and hospitality segments are poised to remain strong.

Owner-occupied purchases may increase as business owners are likely to find better pricing for properties to house their companies rather than paying rent. This was a common phenomenon during the latter half of 2022.

Expect lenders to push for owner-occupied transactions since they allow for the ability to cross-sell additional products (e.g., merchant services). They also encourage the creation of business operating accounts and depository relationships. Many lenders will look to focus on U.S. Small Business Administration loans to offset risk. Should the economy officially enter a recession, which is highly likely in 2023, it’s expected to be a short and shallow one. As a result, investors will become more able to “cherry pick” attractive properties to purchase.

Even if the recession is brief, however, it could prove to be difficult for mortgage originators. Many lenders will lay off employees in their origination divisions due to reduced sales volumes. In the residential sector, it’s possible that many nonconforming lenders will fall. Operational staff at larger lenders could be decimated and a game of “musical chairs” may play out as those being laid off seek a new employer in the same field. Many will leave the mortgage industry entirely as origination activity probably won’t bounce back enough to warrant the hiring of new employees until 2024 or 2025.

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The real estate and mortgage industries may suffer further before they get better, and 2023 could prove to be a lost year for the residential and commercial sectors alike. But even if this dire prediction comes true, don’t lose heart. Industry professionals who have the knowledge, experience and wherewithal to survive (and even thrive) in this environment will be rewarded when the market emerges from these difficult times and commercial real estate begins to flourish again. ●

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Riding the Inflation Wave

Rob Diodato — Mon, 01 Aug 2022 09:00:00 +0000

A central role of being a commercial mortgage broker is that of an advisor. Offering candid, fact-based advice on a property, sector or the market in general is part of the job.

Experience will provide a basis for the advice brokers give their clients. But what if a broker has not had the experience of living through a point in time — such as the current one — with rising interest rates and historically high inflation? After all, the most recent period with similarly high interest rates and inflation was the late 1970s and early ‘80s, a time in which many of today’s commercial mortgage brokers had yet to enter the industry and others were not yet even born.

Still, that is no excuse for not understanding how inflation and rising interest rates can affect commercial real estate. By researching statistical analysis and the historical perspective of prior inflationary and rising-rate environments, brokers will gain the knowledge needed to offer sound advice to their clients, and they’ll prepare themselves for the future of the market and which sectors to focus on.

Inflation hedge

Historically, real estate has been seen as a hedge against inflation. During inflationary times, property values and rent prices tend to increase. The result is that cash flow also increases and the gains in commercial real estate values generally outpace inflation.

From 1978 to 1980, for example, inflation averaged 10.8%. It peaked in March 1980 at nearly 15%. During the same time period, interest rates averaged nearly 10% and reached an all-time high of 15.8% in 1981.

Looking at publicly traded equity real estate investment trusts (REITs) during these years, however, you’ll find that they had dividend incomes and total returns that averaged a respective 12.2% and 23.1% per year. In 1979, as inflation soared to a 32-year high, returns for REITs averaged 21.2%, according to research conducted by the National Association of Real Estate Investment Trusts and The Wharton School of the University of Pennsylvania.

Regardless of your age or experience as a mortgage broker, it is safe to advise clients that now is a great time to own commercial real estate.

This evidence supports the notion that increases in commercial real estate values outpaced inflation in the late 1970s and early ‘80s. So, there is reason to believe the same pattern will take place today and that investors are far better served focusing on commercial real estate than other types of investments.

For example, take stocks. An overview of the S&P 500 from 1974 to 1981 shows that the index delivered a 4.9% inflation-adjusted annual return, according to research platform Macrotrends. And while inflation averaged 9.3% per year during this time frame, equity REITs produced average annual incomes and returns of 10.2% and 16.3%.

Multifamily focus

So, regardless of your age or experience as a mortgage broker, it is safe to advise clients that now is a great time to own commercial real estate. This is especially true of multifamily housing properties, which are seeing rent increases outpace inflation in many areas of the country.

Why should investors focus on multifamily properties during periods of rising inflation? As previously addressed, inflation increases price appreciation and resulting rent levels. With fewer multifamily projects being developed due to rising labor and material costs, rents tend to increase. And as developments stall, the demand for existing multifamily housing increases and occupancy rates tend to increase as well.

Generally, multifamily properties utilize short-term leases that are no longer than one year, which allow landlords to reset pricing to market rates and combat inflationary pressures. Some landlords even use month-to-month leases, which afford more pricing-power flexibility. Price increases can be passed along to new tenants as long as demand remains high.

Fixed-rate mortgages

For property owners with a fixed-rate mortgage during these periods, the payments (aside from taxes, insurance and other expenses) remain constant. This improves their equity position while reducing the value of money owed in the future. This is a win-win situation.

Interest rate increases resulting from higher inflation can weaken investor demand and negatively impact commercial real estate. As discussed, however, historical data provides evidence that some commercial properties, including multifamily housing, are a good inflation hedge. Fannie Mae’s multifamily outlook for 2022 calls for rent growth of 4% to 5% (about half as much as 2021) and a 5.5% increase in origination volume.

At the same time, inflation and rising interest rates can put a damper on the owner-occupied housing market by making affordability more difficult. Hence, would-be buyers remain or become renters, which also ups demand for rental properties. So, it is easy to see why multifamily may be the sector of choice as investors grapple with inflation in the U.S. and abroad. As a commercial mortgage broker and advisor, this sector should be one to focus on.

Other property options

Another sector of commercial real estate worth focusing on during inflationary periods are triple net lease (NNN) properties. In these arrangements, the tenant pays for the property expenses, including the real estate taxes, insurance and maintenance (in addition to rent and utilities).

In general, NNN properties have performed well when compared to the inflation-adjusted returns through the S&P 500. Triple net lease properties with capitalization rates in the 4.5% to 6.5% range generally realize a 7% to 9% return on investment when all factors are considered.

With annual rent increases and rising costs for taxes, insurance and maintenance handled by the tenant, it is clear that NNN properties provide another viable alternative for investors. Although multifamily costs such as common-area maintenance, management fees, capital expenditures, etc. are borne by the landlord, NNN properties provide guaranteed (and in many cases) recession-proof income without these added expenses.

Other commercial real estate sectors that may benefit during this current period of high inflation are the hospitality and industrial segments. Hotels, which have been beleaguered due to the COVID-19 pandemic, are seeing a dramatic rise in demand as post-crisis leisure travel spikes. In turn, owner-operators are able to adjust their daily room rates to keep pace with inflation and take advantage of the increased demand.

Industrial properties have seen a surge in demand over the past several years due to the rise of e-commerce. Although tenants may seek to execute longer-term leases, owners have the pricing power when it comes to renewing or releasing these properties.

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Each of these sectors are worth a look, whether your client is in the market to buy a single property or a portfolio of investments. Now that you have some perspective on the commercial real estate market during times of inflation and rising interest rates, do your research, focus on the sectors that are poised to do well and advise your clients accordingly. ●

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The Appraisal Process Has Gone Off Course

Rob Diodato — Wed, 02 Mar 2022 02:00:00 +0000

Many mortgage professionals would agree that the appraisal process is broken. It has become inefficient and problematic. It is delaying closings and clogging up loan pipelines. And it also has become increasingly costly.

In some instances, appraisal management companies (AMCs) have lost the control they once wielded, allowing independent appraisers to set the market for pricing and turn times. With the onset of the COVID-19 pandemic and the brisk housing market that followed, appraisers found themselves in high demand, which created an opportunity to enable them to begin dictating inspection dates, turn times and fees. There appears to be a clear supply-and-demand imbalance as there are not enough appraisers to meet the increasing workload from mortgage lenders and originators.

The result is that appraisals often take an inordinate amount of time to complete. The delivery timelines are commonly much longer than what was once the norm — and they can change at the whim of the appraiser with no repercussions. Fees that were once set by the AMC are now being determined by the appraiser. These charges can vary widely based upon location and how busy the appraiser is.

In many cases, this forces borrowers to absorb higher appraisal fees and causes lenders to experience processing delays. It has become apparent that AMCs have turned over the reins with respect to pricing and the completion of reports, which are of utmost importance to lenders, originators and borrowers alike.

Heavy burdens

There is currently a shortage of certified appraisers and not enough new appraisers are entering the market. There are good reasons for this. The qualifications for certification are onerous. The Appraiser Qualifications Board, a federally authorized oversight body, requires certified appraisers to have a college-level education, to complete 200 hours of specialized course work and to obtain 1,500 hours of industry experience within a 12-month period, among other things.

Couple this with the fact that appraisers were stigmatized during the financial crisis of the late 2000s and the appeal of becoming one is diminished even further. Hence, AMCs are having a difficult time finding appraisers to perform inspections. The mortgage industry will likely contend with this problem until borrower demand decreases.

Lenders are free to order their own appraisals, but this has a caveat: It is far more costly for lenders to support an in-house appraisal department as they have to supervise these employees, comply with mounting regulations and keep pace with the technology that drives the industry. AMCs relieve lenders of these expenses and responsibilities, the latter of which are not core competencies of the mortgage industry to begin with.

There is a need for the AMC but not to the extent of a decade ago. These companies came into prominence as a result of the Dodd-Frank Act legislation imposed in the wake of the Great Recession, although they existed for many years before that. Lenders were basically forced to utilize AMCs, not only to comply with increased regulations but to create appraiser independence. This also was a way for lenders to offload the overhead costs by delegating the appraisal process to the AMC.

How is a mortgage originator to know whether the AMC their lender utilizes is a good one? If the AMC takes a higher share of the fee or forces an appraiser to charge less, you and your client may get lower-quality reports. As a result, the AMC also may have a smaller number of appraisers who are willing to accept orders. When you factor in the finite number of appraisers in rural areas, it is easy to understand how this problem persists.

Potential solutions

Can AMCs retake control of pricing and turn times? This may not be possible until such time that demand slows down and appraisers become hungry for business. If and when this happens, detailed pricing should be published by the AMC and these fees should be consistent across the industry — which has yet to occur.

The fees paid to appraisers also should be standardized, although this may prove difficult to accomplish. Some AMCs take a higher split than others, so fewer appraisers choose to be approved with them. Other AMCs take a lower split while allowing the appraiser to dictate pricing and thus have more appraisers to handle assignments. This imbalance is not good for anyone, although many would argue that this is how a free market works.

So, is there an immediate resolution to this predicament? It seems unlikely until homebuying demand slows, appraisal volume dissipates, and the mortgage and appraisal industries as a whole voice their concerns with what has occurred.

What will eventually streamline the appraisal process of the future is increased and improved technology. Mortgage lenders and brokers are increasingly likely to use an automated valuation model (AVM) or collateral desktop analysis (CDA) to keep costs down. These alternative appraisal methods will reduce turn times from weeks to mere minutes while retaining the required independence of a traditional appraisal. And these tools will eliminate human error.

This is what the mortgage industry needs to deal with the currently antiquated appraisal process. Fannie Mae and Freddie Mac implemented appraisal waivers during the pandemic that applied to certain transactions and helped to speed up the processing of loans. These changes may have gone unnoticed by some AMCs and appraisers who have had more business than they can handle.

The appraisal industry will not want to see these waivers become the norm once things slow down, so it behooves them to reevaluate. Secondary market investors rely upon AVMs and CDAs to verify loan eligibility, so it makes sense that they will eventually become the standard for valuations. Until then, however, mortgage professionals may need to suffer through the appraisal process. ●

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Step Outside Your Comfort Zone

Rob Diodato — Wed, 30 Jun 2021 20:58:16 +0000

When the commercial real estate market is strong and bank lending parameters are relaxed, mortgage brokers tend to focus on the standard property types they know can be financed via multiple sources. This is understandable. Why take chances with transactions that can prove difficult when you have a full pipeline of loans that traditional lenders are clamoring for?

In down cycles, however, you have to broaden your horizons and take on niche assets you may have shied away from in the past, such as churches or synagogues, gas stations, auto repair businesses and even aircraft financing. These deals can be highly profitable and help to establish your business in market segments that your competitors may avoid.

Many commercial mortgage brokers fear the unknown, but getting started in a niche may simply involve extra study. First, you will need to find lenders that will finance a church or gas station. You then need to learn what lenders will focus on in terms of loan approval. But understanding how to qualify a church, gas station or even an aircraft is not as intimidating as it may sound.

What can prove most difficult is the on-again, off-again appetite that lenders may have for these types of properties. Surprisingly, many banks will finance a church loan, although the appetite may vary by location. If you finance loans nationwide, for example, the Bible Belt may have more opportunities due to a higher concentration of religious institutions.

If you have no experience in originating these types of deals, you will need to understand the lender’s submission requirements and qualifications. When analyzing a church, lenders will factor in the unique ways that religious institutions raise funds. Churches generate revenue through tithes and offerings. Some also raise money via donations for a specific use, such as a building fund.

Church financing

Lenders look at the church’s audited financial statements to determine how much loan it can qualify for. This calculation is normally in the range of three to three-and-a-half times the institution’s annual revenue. So, if a church records annual revenue of $500,000, it can qualify for a loan of $1.5 million to $1.75 million to buy or refinance real estate.

Churches are nonprofit entities and thus do not file traditional tax returns. In general, individual church members won’t agree to personally guarantee the loan. These factors make the loan a riskier proposition for lenders. The lender must assume future revenue based on past revenue. This can prove tricky, especially given the COVID-19 pandemic and the inability for members to gather, which has hurt the revenue streams of many religious institutions.

Religious entities also tend to add new facilities or make improvements as they grow. Lenders typically will finance projects if improvements can generate additional revenue, such as by adding a daycare center. Some nonbank lenders specialize in lending to houses of worship. So, prior to making a proposal, you should research which lenders have experience and then learn their approval criteria.

Gas station loans

Much the same as churches, gas stations are a special type of asset that can be challenging to finance. Many banks and credit unions will lend on gas stations, but they tend to look closely at the brand, the location, supply agreements and the types of tanks they have in place. Gas stations will always present potential environmental issues, so understanding the local environmental regulations and performing due diligence will be beneficial in guiding clients through the financing process.

Gas stations can sometimes include a convenience store or a restaurant chain. These spaces may be operated by a tenant, so understanding the revenue distribution between the parties is critical. These deals can be arduous and time-consuming. Gas station deals are not for the faint of heart or those with a short attention span. They can take the better part of 12 months due to environmental issues, appraisals and complicated ownership structures.

Take, for example, the recent case of a portfolio of 10 gas stations, which eventually secured a loan for $14 million. To make this deal happen, the mortgage broker had to work with multiple lenders because banks and credit unions typically limit themselves to $5 million in exposure. Getting all lenders on the same page was a challenge. Despite its hurdles, however, this deal was eventually successful. It also was lucrative for the broker and will likely lead to other opportunities. Taking on a new niche expands your knowledge and repertoire.

Broadening your focus to include underserved property types, such as houses of worship, gas stations or aircraft, is a great way to set yourself apart from the competition.

Beyond real estate

Brokers also can launch into lending niches outside of real estate, which can prove lucrative while indirectly supporting their real estate financing business. One natural area of specialty lending, for example, is financing for aircraft or boats.

Many banks will lend on aircraft and these deals tend to be large. Determining which lender to use normally depends on the age of the aircraft, its intended use and whether the client has a banking relationship with the lender. Take, for example, a recent deal involving two aircraft loans for the same client. The borrower had done previous real estate financing deals, resulting in sizable and profitable transactions for the broker.

To take on a deal like this, however, the broker needed to research lender guidelines and the borrower profile had to ensure a smooth transaction. Lenders evaluate aircraft differently than commercial real estate. The key factors have more to do with the age of the aircraft and whether it will be used for personal use or for business charters. Another critical component is whether the aircraft has an engine maintenance plan. Aircraft that do not have a plan generally will have limited, if any, financing options.

As with real estate, you still need to compile the requisite financial information and liquidity verification, but you also need to provide ownership experience, projected flight hours, engine maintenance plans and management company information. Personal-use aircraft normally require lower downpayments as little as 15% and can be offered with longer amortization periods of up to 20 years.

Typically, the higher the downpayment, the longer the term available. Aircraft purchased for charter use will require larger downpayments of 20% to 30%. Older aircraft will command shorter amortization periods of seven, 10 or 15 years. All types of aircraft loans normally have fixed-rate terms with a balloon payment due at the end.

Unlike commercial mortgages, there is no reset option for aircraft loans and they often have a prepayment penalty period. The monthly payment works just like a mortgage, however, with the bulk of the payment going toward interest rather than principal during the first few years. For example, if a client makes the minimum monthly payment on a 20-year loan, they’ll gain about 2% equity in the plane in the first year. As time goes on, the principal increases and the interest decreases.

The bottom line is that aircraft financing is a good side niche. Not only can it be lucrative for the broker, it keeps you in contact with an affluent client base that could lead to more commercial mortgage business.

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Broadening your focus to include underserved property types, such as houses of worship, gas stations or aircraft, is a great way to set yourself apart from the competition. Diversification is crucial for continued success so you do not become too dependent on one or two segments of the market. If these segments experience a downturn, it can greatly affect your income. This philosophy will prove fruitful and lead to more opportunities to generate revenue that previously were overlooked. ●

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Survive in a Tougher Market

Rob Diodato — Tue, 29 Sep 2020 23:19:12 +0000

These are trying times for commercial mortgage brokers, lenders and borrowers alike. The post-coronavirus commercial real estate market will be far different than the one in March 2020 prior to the pandemic.

Before the crisis, it was easy for the typical broker to get complacent. The market seemed to be on a long, unimpeded run as we entered this year. The values of many commercial asset types hit record highs as a result of the Federal Reserve stimulus and historically low interest rates propping up the market. Today’s market is much different, however, and many companies are facing a day of reckoning. Brokers will struggle to stay in business if they do not expand beyond their traditional territory and broaden their focus to include multiple commercial real estate asset types.

Seasoned commercial mortgage brokers who weathered the previous financial crisis during the Great Recession understand that you must diversify and remain flexible to survive and thrive in a fluctuating market. They also know that with every crisis, the commercial real estate market emerges on the other side of the cycle with added opportunity.

The financial crisis of a decade ago devastated the market for several years, but it also spawned the growth of the private equity market in commercial real estate. Likewise, the savings and loan crisis of the 1980s pummeled the commercial real estate market, but that led to the birth of commercial mortgage-backed securities. Each of these events increased the financing options for the mortgage brokers who survived.

Commercial real estate bubbles that burst, as well as Black Swan events such as COVID-19, typically thin the herd of commercial mortgage brokers — especially those who focus exclusively on one segment of the market or on a single geographic location. A broker who finances multiple asset types across several locations has a distinct advantage today. Certain geographic areas are not impacted as greatly as others and some segments of the market are flourishing despite the challenges.

Commercial real estate bubbles that burst, as well as Black Swan events such as COVID-19, typically thin the herd of commercial mortgage brokers.

Tougher standards

Today’s mortgage broker has to work harder to get deals approved. Now more than ever, it is important for brokers to vet clients.

Lenders are scrutinizing a borrower’s business or employment income. If a borrower entered into a forbearance agreement on their commercial mortgage, home loan, auto loan or even credit cards, lenders are walking away from these borrowers and their corresponding deals due to concerns about the borrower’s ability to repay a loan. Lenders also are more carefully evaluating the borrower’s property holdings and payment history.

Additionally, lenders are wary of current or recent hot spots for COVID-19, and states where reopening phases have been delayed or rolled back. Many lenders have stopped funding deals in areas with spikes in coronavirus cases, since it raises the lender’s risk if the state is shut down again. This is akin to virus-related redlining, and it will certainly be prevalent until an effective vaccine has been introduced.

Lenders also are taking the same wait-and-see approach on properties where tenants are starting to reopen their businesses. They want to see several months or more of revenue data to determine how these properties will perform compared to the past. Before approving a loan, the lender wants more assurance that the property will do well, regardless of whether the property is owner-occupied or leased.

To survive as a broker in this new environment, you must first determine the lender appetite for each asset class and any guideline changes being imposed, and then market for these types of deals. For the most part, lenders are now wary of higher-risk property types in specific locations, such as office properties in urban areas. Hotels and restaurants, among other niche property types, will face challenges for some time. Lenders will gravitate away from high-risk assets for the foreseeable future. Retail also will struggle as the pandemic has conditioned more people to shop online. Many retailers will likely close or enter bankruptcy.

Another likely casualty is the small business. As the health crisis drags on, more mom-and-pop businesses will fail. This will make it far more difficult to finance unanchored strip retail and small mixed-use properties. Many of these small-business owners also are home-owners. So, the devastation could eventually spill over to the residential sector. Multifamily will face some headwinds if federal stimulus efforts end, businesses shut down and unemployment remains high. Moratoriums on rent payments and evictions have already put pressure on apartment owners.

To survive as a broker in this new environment, you must first determine the lender appetite for each asset class and any guideline changes being imposed, and then market for these types of deals.

A wider focus

The key to getting a deal funded is to focus on property types and locations where lenders are still active, albeit with more conservative terms. Importantly, brokers must clearly explain to borrowers the realities of this much tighter market. Your clients need to have realistic expectations, and be prepared for the extra scrutiny and security lenders now seek, such as requiring the borrower to keep enough cash in reserve to cover 12 months of principal and interest on the loan.

Brokers who specialized in a particular asset class in one city before COVID-19 could struggle to stay in business. Take the example of multifamily assets in New York. Prior to the pandemic, there were ample financing options and a seemingly insatiable appetite from investors to buy apartment buildings. Those days are over. Some lenders will still finance multifamily properties in New York, but the property must have a good operating history and an owner with extensive experience. The borrower also must be willing to take a loan with more conditions.

Some lenders in New York also are gravitating to the abundant rent-subsidized sector for the implied guarantee of rental income. To finance these deals, however, brokers have to look harder for lenders, and establish relationships with nonbanks that specialize in interim and bridge financing.

For the foreseeable future, properties that include essential businesses will have a far better chance of obtaining financing than those without. Property owners who have entered into forbearance, whether on the subject property or any other holdings, will be viewed negatively by lenders.

Preferred assets

Certain segments of the market, however, are thriving in this environment. The outlook for the single-family rental market is excellent. Renters are fleeing densely populated urban areas for single-family rentals in the suburbs that afford privacy, social distancing, a yard and perhaps a pool. Financing is readily available on multiple fronts for the single-family investor market, including fix-and-flip, buy-to-rent and portfolio mortgages.

Another segment of the market with increased investment activity is the single-tenant, triple-net lease space (also known as NNN), although not all tenants in this market appeal to lenders. Those that do include Dollar General, Dollar Tree and Walgreens, just to name a few. Typically, the loan amounts are higher in this space and the deals are larger. So, if you turn your attention here, you can close fewer deals and still succeed.

Another niche sector that remains in favor with lenders is medical-practice financing sought by doctors and medical professionals to establish a business. Sometimes, the client wants to finance a commercial condominium or co-op. Other times, it may be for an entire building. These types of deals can include financing for build-out or equipment. In this space, the U.S. Small Business Administration tends to offer mortgages with higher loan-to-value ratios.

● ● ●

For any brokers who limited their financing programs in pre-COVID times, this is a great time to expand into other asset classes and offset the loss in revenue from other segments. Brokers who have been lending in multiple states and on various property types will not just survive, but thrive, and with less competition.

The new mantra is “evolve or die.” Brokers who reposition themselves and offer financing for multiple property segments and locations will see continued growth. ●

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Be the Referral Guru

Rob Diodato — Fri, 28 Feb 2020 18:15:21 +0000

The ultimate goal of any commercial mortgage originator is to have an exclusively referral-based business. Getting there, however, can take considerable time and effort. And once you arrive, you can never have enough referral sources and must continue to find new ones.

Sourcing new loans can be the most challenging aspect of a commercial mortgage broker’s job. To get a steady number of referrals, the originator must be perceived as knowledgeable and an expert in commercial real estate finance, but you also need your clients to spread that word about you. Otherwise, your success will be limited.

What is the best method to source new deals? That depends on the commercial mortgage broker, but all originators should look at every transaction as a means to establish one or more referral sources. The typical purchase transaction usually involves Realtors, attorneys and a title company, as well as the seller and your borrower. Each party should be viewed as a potential referral source.

You should make it a point to correspond with each party and advise them about the financing process. Your effort will not only keep all parties abreast of what is happening with the loan, it also will demonstrate your expertise, knowledge and efficiency that will hopefully result in doing more business with one or more of the parties.

Commercial Realtors, especially, love a mortgage broker who keeps them in the loop. They appreciate an originator who will fight for their deal and protect their commission. This attention to detail will result in future business. Let’s face it, a referral is the best new prospect you can hope for as they come with an introduction from a party who was previously satisfied with your services. You have gained a certain level of trust, so the job of bringing in their loan is far less challenging. Your success rate in closing a loan with a prospect is far higher as a result. But this is not the only way to source new deals.

Most residential originators are quick to advise their colleagues when they have found a professional commercial mortgage broker who can deliver and make them look good in the process.

Residential connections

As a commercial mortgage broker, it is not uncommon to stumble upon your fair share of residential mortgages, especially if you offer a product line for nonowner-occupied residential loans. Residential originators also have commercial loans fall into their lap, yet most lack the knowledge or expertise to undertake a commercial transaction, or are unable to offer commercial real estate financing through their company. This means residential originators can be excellent referral partners.

As with your relationships with clients, it can take some time to gain the trust of a residential originator. A residential broker or lender may have had a bad experience referring deals to an unprofessional commercial mortgage broker. Once the relationship is established, however, it can be a wildly successful model to generate leads.

You should focus on building these relationships with seasoned, professional residential originators who can deliver good prospects. You’ll need to weed out the ones who can’t send viable loan candidates. What you will find, however, is that once you have gained the full faith and trust of a reliable residential originator, others will follow. Most residential originators are quick to advise their colleagues when they have found a professional commercial mortgage broker who can deliver and make them look good in the process.

Residential mortgage originators can contribute to your origination volume and enhance your other sources of new business. They have the ability to exponentially spread the word of your services, which can prove to be a valued source of future business for any commercial mortgage originator.

Using social media

There are other ways to find new clients. Social media can be a great way to attract new business. Sites designed for businesses, such as Linkedin, are great platforms. You are able to make new contacts with commercial real estate brokers and borrowers on the site. You can share information and content that may draw the attention of borrowers, Realtors or residential originators, as well as post details of your product offerings.

Social media allows you to reach the market you desire from your keyboard, without having to take one-on-one meetings or venture into an office with a box of doughnuts and some fliers. You are able to reach a larger audience whom you know have an interest in commercial real estate and possibly your services.

Online, fee-based platforms are available that provide an abundance of origination opportunities. Reonomy, for example, offers a service where you can research properties in a particular location, then obtain owner information and details on current financing, including the loan terms. It takes some time to mine for these contacts and then cold call or e-mail them. The pull-through rate will likely be lower, but it can still complement your other marketing efforts while leading to potential referrals or repeat business.

The use of e-mail marketing is another open avenue that a commercial mortgage broker should explore. Services such as iContact or Constant Contact enable you to create e-mail-ready fliers that can be distributed to your target audience. You can create lists of Realtors, residential loan officers, attorneys, etc., and market relevant material to them on a recurring basis.

This machine-gun approach allows you to reach a broader audience with the click of a mouse. You also can post the fliers on Linkedin, or any other social media platform that will generate interest in a particular product or program you have to offer. But you must be diligent and consistent, adding to and pruning your lists so that you get the best possible response. Keeping your name and your message out there will lead to new business, but you have to keep at it.

Keeping in touch

All of this leads to one final avenue for sourcing business: past clients. Unlike the insurance industry where you earn residual income each year a client stays in their policy, commercial mortgage brokers get paid once at closing. The most successful originators have made it a long-standing practice to maintain a calendar that alerts them when a prior client is close to the end of their fixed-rate term, regardless if the loan is scheduled to reset. Although many clients reach out directly as the anniversary of their loan approaches, you should make it a point to do so first.

Many clients don’t want to refinance and opt to allow the loan to reset, which is the path of least resistance. However, the broker is doing them a disservice by not letting their clients know about the other available options. The current interest rate environment may not always provide better options but, by contacting all your past clients, you are maintaining contact and deepening a relationship.

Although you may not refinance the original loan with every client, many clients will choose to refinance with you once the term expires. The original deal can become like an annuity, yielding revenue for your business every five, seven or 10 years. Also remember that most commercial real estate investors do not stop at just one property. You want them to think of you for any new property they plan to purchase.

One final word should be said about developing your referral-based business. There is no one-size-fits-all philosophy for sourcing new business. Some strategies will work for some, but not for others. There are many options for finding new business. The successful commercial mortgage broker always maintains a diversified strategy.

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Not An Exact Science

Rob Diodato — Fri, 15 Nov 2019 11:00:00 +0000

You are originating a new commercial real estate loan. You gather all the required information and run the numbers to ensure the debt-service-coverage ratio (DSCR) demonstrates that your borrower has the necessary cash flow to cover the debt at the requested level. You scour your lender list to find the best match and send the deal to a lender, awaiting a letter of intent in return.

But lo and behold, your lender comes back with a different DSCR, which results in a lower loan amount. Now what? Time and effort has been wasted. An anxious client awaits terms. Your calculations are accurate, but you and your lender have come up with different numbers. How could that be? The answer is that the DSCR calculation is not an exact science.

One would think calculating DSCR should be as simple as plugging in the applicable rental income and expenses from the property’s vacancy data and its actual expense reports. It is not that simple, however. Lenders calculate the debt-service-coverage ratio in a range of ways and this can spell the difference between an accepted deal or a lost client. And the math can vary dramatically.

The DSCR is the relationship of a property’s annual net operating income (NOI) to its annual mortgage debt service (principal and interest payments). For example, if a property has $125,000 in net operating income and $100,000 in annual mortgage debt service, the DSCR is 1.25. A higher DSCR typically means that the borrower has a greater cash cushion to service the debt. It tends to qualify the borrower for a larger loan amount.

Key metrics

For almost all lenders, the debt-service-coverage ratio is the primary method for determining a borrower’s eligibility. It is a key metric, but it is not the only one. The property type, geographic location and loan-to-value (LTV) ratio all have to meet that lender’s requirements. DSCR is normally limited to investment properties. For owner-occupied properties, lenders tend to more closely evaluate the net operating income of the business to ensure that the business can service the new debt.

It is important to understand that there are other qualifying ratios that can adversely impact a commercial real estate loan application. In addition to meeting minimum DSCR standards for your lender, most lenders also now look at global cash flow. Even though your borrower may meet the minimum DSCR requirements, if your client’s global cash flow does not adhere to what is normally a one-to-one ratio that ensures the borrower has enough cash to pay off their debt obligations, you do not have a deal. So, you also must weigh a client’s income and liabilities when submitting a loan request.

That being said, DSCR is a fundamental metric in almost every commercial real estate deal. The calculation can be influenced significantly in three general ways.

Crunching numbers

First, lenders can assume vastly different vacancy rates for a property. There are no set of rules that lenders use to determine a standard vacancy factor. The assumed vacancy rate can be anywhere from 3% to 10%, so mortgage brokers need to be careful when applying a vacancy rate in their calculation of DSCR.

Normally, lenders assume a vacancy rate of 5% for a residential-investment property, and 10% for an office, retail or industrial property. Mixed-use properties can further complicate the DSCR calculation, given the mix of commercial and residential uses. Some lenders will apply a 7% vacancy factor for the entire property, while others may use a 5% rate for the residential units and 10% for the commercial component.

The key point is that the assumed vacancy rate can have a dramatic impact on DSCR. The higher the assumed vacancy factor, the lower the net operating income. Again, you should ask the lender about their assumptions before submitting your application, so you can feel confident that the loan meets that lender’s requirements.

The DSCR also can fall below a lender’s minimum standards if the lender assumes higher property expenses. Some lenders use a set expense factor rather than the numbers that are reported as expenses on the tax documents used by individual owners, partnerships or corporations. This expense factor can range from 30% to 40% of the gross income from rents that are collected, and it can prove to be much higher than the actual expenses. Brokers should be wary of lenders that automatically assume high property expenses in their calculations.

Some lenders use historical expense reports, but include items that other lenders will ignore. For example, some lenders include reserves for costs such as maintenance, legal and property-management fees. These items can throw a DSCR out of whack and cause the deal not to qualify. Assuming higher annual property expenses will lower DSCR and the other primary values used to calculate the loan-to-value ratio. All of these factors will ultimately determine a borrower’s eligibility for a loan at the requested level. Be sure to have your lender itemize which expenses will be included in their calculations, so that you are not taken by surprise later on and left scrambling to find a home for your loan.

Some lenders also use stress testing to assess how the property might perform under hypothetically adverse conditions. This is a less common practice, but it still can be a reason for a loan not qualifying. In determining eligibility, for example, lenders may apply a higher interest rate of as much as 2%, or they may use a higher qualifying debt-service- coverage ratio. Stress testing offers lenders another degree of security for a commercial real estate transaction, but it can hamper your ability to get otherwise solid transactions qualified.

Alternative methods

Sometimes a property’s DSCR falls below minimum thresholds for any conventional lenders, regardless of what methodology is used. Your borrower has to look for other options. Many nonbank lenders, however, either do not use DSCR or use an abbreviated calculation.

Although many lenders will strictly limit these loans to residential-investment properties, some will offer them on other types of commercial property. Due to the higher inherent risk, these loans normally carry much higher interest rates, but they allow a borrower to purchase a property and raise rents. The borrower can then refinance the loan at a later date under more favorable terms.

You will need to do your homework prior to choosing a path for deals that fall within these parameters. These products fill a void and can enable you to close more loans that may not qualify with conventional lenders. These loans also can present an alternative to hard money or bridge financing, which can carry even higher rates and fees.

• • •

Lenders calculate DSCR in various ways. One lender may qualify a loan with a higher rate and shorter amortization. Another lender that calculates DSCR differently may offer a lower rate and a longer term. Get to know how your lenders qualify borrowers and keep the information handy. This knowledge can help prevent delays and should ultimately help your client get the best deal.

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Leverage Can Amplify Return on Investment

Rob Diodato — Wed, 16 Oct 2019 18:57:54 +0000

Commercial mortgage brokers, for the most part, would agree that leverage in a financing package is a useful and necessary tool for any of their real estate investor clients. Leverage, or the ratio of debt to value, can influence the risk and reward of real estate transactions. The benefits include, among other things, reducing the initial investment required to close the deal, as well as potential tax write-offs on the interest paid on the resulting debt.

Real estate owners and developers rely on leverage in order to maximize their return on investment (ROI). The use of leverage can increase ROI because the cost of financing is usually cheaper than the unleveraged returns a property can generate.

Compare three commercial real estate investors, for example, all with $1 million to invest. One investor utilizes no leverage to buy a $1 million property, another uses 50 percent leverage to buy a $2 million property and the other uses 75 percent leverage to buy a $4 million property. Then, assume 10 percent price appreciation on the property after purchase.

In such a scenario, the second investor with 50 percent leverage would realize a gross ROI double that of the first investor with no leverage. The third investor would realize a gross ROI quadruple that of the all-cash investor and double the gross ROI realized by the second investor. Investors simply get more bang for their buck by utilizing leverage and are able to create additional returns as a result.

Opportunity knocks

Given the potential to expand ROI using leverage, one would think it would be used in most, if not all, real estate transactions. All-cash transactions, however, still account for a large segment of the real estate purchase market.

For the most part, leverage is utilized by most first-time homebuyers in the residential sector. Investors in the residential sector, who are able to finance purchases with commercial loan products, utilize leverage far more frequently, but still not as much as might be expected, given the potential advantages for ROI.

The fix-and-flip market offers a window into the use of leverage in commercial real estate transactions. In that market, investors buy homes, rehab them as fast as possible and then resell the houses, hoping to make a profit on the increase in market value. In second-quarter 2017, only 35 percent of homes flipped nationwide were acquired by flippers using financing, although this percentage was a nearly nine-year high and up from 33.2 percent the prior quarter, according to a report by Attom Data Solutions.

“ Commercial mortgage brokers should seek to maximize their clients’ leverage on less risky investments. ”

When an investor uses all cash, assuming they have the financial viability to do so, the resulting lack of liquidity can stand in the way of additional opportunities. Leverage can take the form of a mortgage on a single commercial property, a blanket lien on multiple properties or a line of credit that can be utilized repeatedly for fix-and-flip residential transactions. It allows real estate investors to diversify and exponentially multiply their ROI. The rise of commercial lenders in the fix-and-flip and buy-and-hold rental segments of the real estate market has expanded financing options for investors.

This development has resulted in many commercial mortgage brokers expanding their areas of expertise to include financing products already afforded to investors for residential properties. One of the products being offered through commercial mortgage brokers and utilized more frequently in the current market is the line of credit, which is normally geared toward the fix-and-flip investor seeking to keep their cash liquid and to capitalize on far more home-flipping transactions.

These lines of credit can finance up to 90 percent of the purchase price and 95 percent of the rehab costs, depending on the lender as well as the experience, liquidity, net worth and FICO credit scores of the borrower. Nonrecourse lines of credit are available to highly experienced real estate investors, which is an attractive incentive for those who qualify. There is increased competition for investors to find value for buy-and-hold or fix-and-flip properties. As opportunities diminish with changing market conditions, however, the need to capitalize on them quickly becomes paramount.

Crunch the numbers

For an investor with limited cash, it can take up valuable time to buy one property at a time, rehab it, and then market it for sale. During that time, other opportunities that present themselves could come and go. These are opportunities that could be taken advantage of with the use of leverage.

A line-of-credit product allows an investor to leverage liquidity by a factor of up to five times, giving those who use it a distinct advantage in the market, given the speed with which they can act on a potential deal thanks to that added liquidity.

Leverage can be a double-edged sword, however. It can lead to higher risk of loan default if not used prudently. While lenders impose certain underwriting guidelines that are designed to limit over-leveraging, it is ultimately the commercial mortgage broker’s expertise that can be one of the best guides for investors on the use and limits of leverage.

Brokers should analyze and compare the internal rate of return (IRR) on a transaction with the investor to determine whether leverage is prudent for a given deal. The IRR is a metric used to determine the potential profitability of a real estate investment. Generally speaking, the higher a project’s IRR, the more desirable it is to pursue the deal. After risk-adjusted returns are calculated, an educated investment decision can be made.

• • •

Commercial mortgage brokers should seek to maximize their clients’ leverage on less risky investments, such as a deal involving a triple-net lease on a property that is in a desirable location and has a highly rated long-term tenant. Maximizing leverage also should be explored for commercial real estate projects or investments proposed in geographic areas with higher yields.

Finally, it is prudent for commercial mortgage brokers to counsel investors about the perils of being over-leveraged, especially with respect to low-yield investments. Recent real estate history is testament to how being over-leveraged during a severe downturn can lead to financial ruin. Weigh the pros and cons of leverage with your clients so that you establish a solid foundation for future business dealings together.

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Niche Products Open Doors

Rob Diodato — Tue, 17 Sep 2019 17:47:52 +0000

Niche loan products and services are the key to any successful marketing campaign. They enable commercial mortgage brokers to establish new referral sources that otherwise may not have been responsive.

Niche products are a conversation starter. They set you apart from the competition. They allow mortgage brokers and lenders to say “yes” to deals more often. And they enhance your revenue stream.

Commercial real estate agents are often deluged by originators who peddle flyers offering loan programs and services that usually have no discernible difference from each other. In addition, many Realtors have long-standing relationships with mortgage brokers who they feel comfortable with, so over-coming their reluctance to establishing a new relationship can be hard to accomplish.

This is where an introduction to your niche products can come in handy. The same Realtors, as a result of their hesitancy, may be oblivious to the opportunities afforded by niche products.

Realtors may find it difficult to resist an originator who asks about their deals that could not get done, to see if there was a loan program available that could accommodate the transaction and earn the Realtor a commission. It is better (and easier) to set up a meeting with a new referral source by asking them to discuss the deals they lost rather than walking in with doughnuts and a rate sheet.

Niche-loan examples

Regardless of the space in which you originate commercial mortgages, there is probably a niche product (or products) that can enhance your matrix and help you close more loans. Some mortgage brokers are fearful of establishing new relationships with lenders that offer niche products, given they have no prior experience with them. Certainly, that can be a cause for concern as you do not want to jeopardize a referral source or client. There are no rewards, however, for those who do not take risks.

The majority of lenders that offer niche programs are well-established in the marketplace. In addition, niche products afford you options for deals that may not qualify for conventional loans because of a multitude of factors. This is not to say that niche programs are offered only by nonbank lenders. If you primarily originate multifamily loans, for example, there are conventional lenders that do not require a borrower’s tax returns or historical income and expenses.

Some transactions through the government-sponsored enterprises Fannie Mae and Freddie Mac also do not require tax returns from the guarantor. Some conventional lenders will allow you to close on a vacant property using market rents to qualify. Other lenders will work with borrowers who have, for example, an outstanding violation from a city’s environmental control board or department of buildings, or those with FICO scores as low as 620.

Depending on how aggressive you want to be in offering niche programs, you can find loans with low minimum debt-service-coverage ratio requirements; “low FICO” products for borrowers with credit scores below 500; stated-income and no-ratio loans that reduce or eliminate income-verification requirements; and even owner-occupied commercial real estate transactions that rely mainly on a business’ profit and loss statements.

All of the above are examples of niche loans, and the ability to accommodate transactions that happen to meet any or all of these factors equates to more closed loans. Although a lender or mortgage broker may receive many referrals from conventional sources, they often close more loans when there are obstacles to conventional financing, and they are able to provide viable solutions. That is the main benefit of niche lending.

For the most part, the commercial real estate lending landscape has taken on a similar shape as the low-documentation Alt-A market of a decade ago within the residential mortgage space. Whether that is a good thing or a bad thing can be debated.

It is irrefutable, however, that these additional options afforded to commercial mortgage originators provide more avenues to get deals done and, as a result, open up the possibility for relationships with more referral sources and clients. It also should be noted that many of these niche products come with conventional interest rates, and those offered by nonbank lenders normally come with “soft-money” terms that are a viable and less-costly alternative to traditional hard money loans.

Unique property types

Niche lending is not limited to products, however. It also includes numerous property types that conventional lenders may not finance for any number of reasons. Properties such as gas stations, car washes and auto-repair shops, for example, may pose environmental issues that can deter conventional lenders from financing them.

The U.S. Small Business Administration will only finance certain niche property types if they are owner-occupied transactions, so there is a void to be filled by lenders willing to finance these property types as investor deals. The niche-property space has become a larger share of the commercial mortgage market, and brokers can benefit from this evolution — if they are able to line up financing terms for a sports-complex acquisition, church construction or purchase of a vacant mixed-use building, just to name a few examples.

Another potentially beneficial niche property type is medical-office financing, where you can provide for the business-purpose purchase of a condominium, co-op or single-family home while simultaneously financing the build-out or equipment acquisitions. A mortgage broker may develop a contact list filled with doctors, dentists, surgeons and veterinarians who become repeat clients or refer new clients.

Geographic location may be a determining factor for the types of niche products or properties you offer to clients. In areas where co-ops are prominent, for example, offering underlying co-op financing or bulk-share loans (in which a loan is secured by multiple co-op units owned by the same borrower or entity) can be construed as a niche product that is not offered by some conventional lenders.

For areas of the country in which condos are prevalent, you may be able to provide financing to a homeowners association (HOA) for a property purchase, or deal with “fractured condo” transactions in which multiple housing units have gone unsold and are available for a bulk purchase. Maybe you work in the Bible Belt and want to offer acquisition or construction financing of churches to enhance your share of the market with lenders that specialize in these properties.

• • •

Any or all of these niche programs and property types may prove to be lucrative offerings that enhance your position in the marketplace. As a commercial mortgage broker, the more property types you can finance — and the more options you have to finance them with — the better your odds are for success.

As we quickly approach the tail end of a nearly decade-long run of growth in the commercial real estate market, one could argue the low-hanging fruit has been picked. Conventional lenders are becoming more conservative and are limiting the property types they will finance. As interest rates and cap rates rise, fewer deals will qualify through these sources, so the need for niche-lending connections has never been more critical to your future success.

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