The danger is that the current high interest rate environment will make refinancing the loans on devalued properties difficult and expensive, resulting in waves of defaults and more pain for everyone involved. A lot of numbers have been bandied about concerning the volume of loan maturities, but according to the Mortgage Bankers Association (MBA), of the $4.6 trillion in existing commercial real estate loans, about $2.6 trillion will mature in the next four years.

This issue became real in February 2023 when Canadian real estate conglomerate Brookfield walked way from $784 million in loans connected to two office towers in downtown Los Angeles. At the time, media outlets reported that Brookfield had made it clear months earlier that it might not be able to refinance debt obligations on the properties. Brookfield was described as a bellwether for where the office market was headed — and it wasn’t alone. That same month, Columbia Property Trust defaulted on about $1.7 billion in debt tied to seven major properties.

The defaults by two high-profile landlords helped to solidify a sense of foreboding, which has continued to this day. In this issue of Scotsman Guide, in fact, author Rob Finlay writes about the refinancing problem (“Scale the Wall of Maturities” on Page 30) and discusses what mortgage originators can do to help mitigate the impact.

What’s unclear is how large this massive wave of refinancing needs will be. Yes, the default rate is up and there have been a few high-profile cases, but the disaster has yet to hit commercial real estate on a wide scale. Is it possible it won’t?

Jamie Woodwell, the MBA’s vice president of research and economics, explains that there are aspects of this problem that industry watchers need to keep in mind. This includes the fact that loan maturities are spread over a long period of time, in a wide variety of industries and in every geographic location, so the results will be as varied as the properties in question.

Other factors may help to lessen some of the damage, or at least spread it out. For instance, Woodwell found that of the $4.6 trillion in commercial real estate debt, nearly $2 trillion is for multifamily properties, a relatively strong sector with typically longer loan terms than other asset classes. Less than 10% of multifamily debt was set to mature in 2023, but there will be more in later years. For instance, about 16% of current multifamily debt will be due in 2032 when the economy is bound to look much different than today.

Woodwell remembers when the MBA began creating its lending survey during the global financial crisis of the late 2000s. There were worries then, too, about a wall of maturities combined with limited capital availability.

“One of the key takeaways that we found then, that I think continues to be true today, is that commercial mortgages tend to be a relatively long-lived asset,” Woodwell says. “You have an awful lot of loan types out there and, among them, commercial mortgages tend to be longer in nature. So, even now in the peak of 2023, with the greatest volume of maturities in our survey, it’s still only 16% of the total outstanding balance.”

Inflation was also reported to be falling quickly at the end of 2023 and Federal Reserve members have said that rate cuts are in the offing. Such a move would greatly lessen the sting of refinancing.

That’s not to say that commercial real estate isn’t stressed. Property values have cratered, with Capital Economics recently estimating that overall commercial real estate values fell 11% in 2023 alone and are expected to shed another 10% this year. The office sector, alone is expected to lose another 20% in 2024.

Woodwell says there’s a great deal of uncertainty about where property values stand. But it’s clear that delinquencies are on the rise. Woodwell points out that, through the first 10 months of last year, delinquencies rose in all asset classes, with the office delinquency rate exceeding those of hospitality and retail for the first time since the onset of the COVID-19 pandemic. “We are seeing stress in the market,” Woodwell says. “Pretty much every capital source has reported an increase in delinquency rates.”

One sector that may do better than expected is retail. Capital Economics expects retail valuations to increase by 6% per year through 2028. Plenty of retail sites remain under stress, but Chris Angelone, the co-leader of JLL’s national retail group, believes that poorly run operations have already been flushed out, so the owners now in place at the better-performing malls are often the best operators. Lenders would be loathe to take back those properties when quality operators are already in place.

“I think, generally speaking, that lenders are going to work with their borrowers on performing assets,” Angelone says. “But obviously, the valuations are going to be much different than before.” ●

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“Projects in need of critical repairs or that have significant deferred maintenance can result in unsafe living conditions, evacuations and uninhabitable homes,” a Fannie Mae spokesperson writes in an email. “In addition, special assessments for these types of issues can result in a substantial financial hardship for homeowners — especially low-income or first-time homebuyers — which can put them at risk for loan default and foreclosure.”

One of the practical effects of these changes is that more condo loans are being rejected or delayed, says Dawn Bauman, chief strategy officer for the Community Associations Institute, which advocates for condo associations as well as the 74 million people living in these developments. Her organization sent a survey to members last year. Of the 541 respondents, about one-quarter said that loans in their condominium developments were denied due to the new requirements while more than one-third experienced significant delays.

Bauman says that she’s concerned that the new rules apply to all condo projects with five or more attached units. Bauman also says that her membership learned that Fannie Mae maintains a list of condo projects for which they won’t purchase loans.

“The ineligible blacklist came to the surface after all of this,” Bauman says. “It was like, ‘Wait a second. There’s a list, actually?’ While it existed before, it wasn’t as big of a deal before because there weren’t that many projects on that list. It then became just a bigger deal after the new requirements came out.”

The Boston Globe reported last year that the number of U.S. condo projects on this list had grown to more than 2,300. Data and technology company CondoTek told the newspaper that the list numbered fewer than 300 projects the year before.

Fannie Mae reports that only 1.2% of condo projects were labeled as “unavailable” as of this past June. The agency also says that condo loan acquisitions totaled 9% of its single-family conventional business in both 2021 and 2022, an increase from 8% in 2020.

“Most projects that are currently listed as unavailable have other eligibility issues, such as active or pending significant litigation, hotel- or resort-type characteristics with transient occupancy, too much commercial space, or inadequate insurance,” according to Fannie Mae.

The Community Associations Institute, the Community Home Lenders of America (CHLA) and the National Association of Realtors asked the GSEs and its regulator, the Federal Housing Finance Agency, for more transparency about the list of nonwarrantable projects. This past December, the GSEs annnounced plans to create an online tool for homeowners associations to identify whether they are on the list and what they need to do to be removed.

CHLA executive director Scott Olson applauds the move for increased transparency, saying that if the GSEs identify problems with a condo development, the association should be made aware so it can fix them. Olson says that his organization has been focused on prevention of overreactive policies. He hopes that the GSEs and other regulators scrutinize the underlying causes of the Champlain Towers South disaster. 

“You should worry about older buildings; you should worry about high rises,” Olson says. “You should worry about areas where there’s a lot of water. That was a big problem with Surfside — the water erosion. You shouldn’t just overreact and be really tough on everything.”

Bauman notes that condominiums tend to be an affordable option for first-time homebuyers, retirees and everyone in between. She remains concerned about what could cause the GSEs to reject loans from condo developments. Those could be everything from insurance requirements to special assessments. She notes that homeowners associations commonly levy assessments for such things as lobby construction or common-area improvements. What types of assessments could cause more delays or denials for condo loans?

“Transparency is awesome, of course,” Bauman says. “The next step will be to really evaluate whether these are reasonable requirements, or addressing liability concerns for Fannie Mae and Freddie Mac, while making sure they’re doing what they’re supposed to be doing for the American people, which is putting liquidity into the marketplace.” ●

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The subject of at least two books that was also mythologized in a Hulu documentary, WeWork — which at one point was estimated to be worth $47 billion — filed for chapter 11 bankruptcy this past November. The charismatic co-founder Adam Neumann, with his rock-star hair and flair for excess, is long gone, fired by the company’s board of directors in 2019 and walking away a billionaire, at least on paper.

When it comes to studying what went wrong with WeWork, the list is long, including a flawed business model in which the company made long-term leases on office space and then offered short-term rentals to individuals, startups and small businesses. The operation lost money during the best of times, leaving it unable to cope with the COVID-19 pandemic and changing attitudes about office work.

“WeWork is going to reject more leases than ‘The Golden Bachelor’ rejected potential suitors.”

Eric Sussman, adjunct professor of accounting, UCLA Anderson School of Management

There are many ironies to this story, including how some of the most powerful investors in the world were sucked into the WeWork vortex. They apparently believed Neumann’s hype that his operation would be a disruptive force in commercial real estate. But surely one of the most surprising twists is that the story doesn’t seem to be ending — at least not yet. WeWork, which still maintained 777 locations across 39 countries as of June 2023, is still alive and may end up coming out of bankruptcy as a viable company.

“The purpose of chapter 11 reorganization is to give the business a second chance at life,” says attorney Anthony Sabino, who specializes in bankruptcies. “Under chapter 11, a debtor company is explicitly allowed to continue to operate its business and maintain possession of its assets.”

Sabino says that WeWork will be able to accept or reject each of its unexpired leases. The accepted leases will either be paid or sold off while the rejected leases will become unsecured debts. “They will go to the back of the line with all the unsecured debtors scrambling for pennies,” Sabino says.

Additionally, the management team stays intact. “That is one of the zany things about chapter 11,” Sabino says. “The incumbent management team is allowed to stay in place, unless creditors unite and go to court to have them removed.”

All indications are that WeWork’s management team is moving fast on the reorganization. The Wall Street Journal reported that WeWork was proposing to reject 69 poorly performing leases, including 40 locations in New York City, and was negotiating with more than 400 landlords to amend existing leases.

“WeWork is going to reject more leases than ‘The Golden Bachelor’ rejected potential suitors,” quips Eric Sussman, adjunct professor of accounting at UCLA’s Anderson School of Management, referring to ABC’s hit dating show. As for whether the company’s fall will cripple the coworking sector, Sussman, who started a business in a coworking space, doesn’t believe so.

“Coworking has been around for decades,” he says. “WeWork was a flash in the pan with a new variant of the model, with beer kegs, pingpong tables and video games, but I don’t think there is any issue with the traditional coworking space.”

When it comes to lessons learned from this debacle, the last word goes to Aswath Danodaran, a professor of finance at New York University’s Stern School of Business. He made it clear in an email response that he was ready to move on from the WeWork story.

“The bottom line is simple: WeWork has always been a bad business with an awful management team,” Danodaran writes. “One VC (Softbank) pushed their pricing up to $47 billion before they fell apart, brought down by arrogance. It was deserved and no tears are being shed.

“If there are lessons to be learned, they are don’t be arrogant and [then] compound that arrogance with greed. But that lesson will never be learned. There will be more WeWorks in the future, with different players and different motives.” ●

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First American Financial Corp. reported that U.S. home prices peaked for a seventh straight month in October 2023. Annualized price growth at that time increased to 7% after bottoming out in the first half of the year. Meanwhile, Attom reported that nearly half of residential properties with mortgages in third-quarter 2023 were considered “equity rich,” meaning the amount of debt secured by these homes didn’t exceed 50% of their estimated market values.

At a time when home purchase business remains tepid, originators who once overlooked home equity lending products might want to reconsider them. Many lenders have already jumped on the bandwagon: According to data from the Mortgage Bankers Association (MBA), home equity loan and home equity line of credit (HELOC) originations jumped by 50% from 2020 to 2022.

“We see a lot of potential in this space, especially if there are more outlets in the secondary market.”

Marina Walsh, vice president of industry analysis, Mortgage Bankers Association

Across the 20 companies that participated in the MBA’s study, the average origination volume of these loans grew by nearly $1.2 billion during the two-year period. At the end of 2022, homeowners had roughly $31 trillion in total equity, triple the levels seen in the years immediately following the Great Recession.

“We see a lot of potential in this space, especially if there are more outlets in the secondary market,” says Marina Walsh, the MBA’s vice president of industry analysis. Walsh notes that banks are concerned about any loans they’ll hold on their books — particularly after the recent failures of a few institutions — but she also says that alternative lenders are emerging in the home equity channel.

These lenders tend to be fintechs that offer speed and convenience for online applicants, making their home equity loans more competitive against personal loans and credit cards. But they’re also excelling at strong underwriting standards and borrower analytics, Walsh says.

“Unsecured lending is just an easier process for borrowers,” she says. “Some borrowers are still remembering the overleveraging from the Great Recession. A lot of education is needed to show that (an equity-based loan) makes financial sense.”

There are several reasons why these products haven’t been more popular in previous market cycles, says Anthony Stratis, senior director of lending partnerships at Figure, a nonbank HELOC lender. These include a lack of compensation for the mortgage company and originator, few options for selling the loans on the secondary market and long funding times (MBA data pegged the average closing period for a HELOC in 2022 at 41 days).

Yet another potential hurdle, Walsh notes, is the personnel tasked with managing these types of financing requests. Consumer lending divisions, rather than mortgage divisions, were responsible for the bulk of home equity loan and HELOC originations among the lenders surveyed by the MBA.

“I hear more about trying to consolidate consumer products, technology-wise, into one loan origination system, so you have more of the prominent lenders providing a home equity loan add-on,” Walsh says.

Stratis believes that the overarching movement in consumer financial services toward online speed and convenience presents an opportunity to educate both consumers and originators. The modern home equity lending process is increasingly likely to resemble that of a personal loan.

“The credit unions and banks, I think they’re very good at being able to offer these products,” Stratis says. “But the process by which they do it is traditional in the sense that you’ve got manual underwrites that take place and a lot of paperwork going back and forth. … I think that’s a big barrier to a typical consumer, and not one that they necessarily want to go through for a $40,000 or $50,000 loan.” ●

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There is no end to the projects underway, including an ongoing adaptive-reuse plan for Los Angeles, which has been active since 1999, mostly in the city’s downtown core. In the first 15 years of the program, more than 12,000 housing units were developed, many in converted bank buildings. This year, planners have decided to expand the program citywide.

“We are in the Wild West with these projects, and developers like predictability and certainty in what they do.”

– Brooks Howell, residential leader and principal, Gensler

In Chicago, former mayor Lori Lightfoot is championing the LaSalle Street corridor revitalization, a massive $1 billion project that will repurpose 2.3 million square feet of vacant space in the city’s famed central business district into 1,600 mixed-income apartments. New York City also has a conversion program in place, but officials this year proposed state and city zoning changes that would extend flexible conversion regulations to an additional 136 million square feet of office space.

Many academic groups and private research firms are joining up with the adaptive-reuse movement. Many believe this process is a partial answer to the nation’s housing problem. A 2022 Rand Corp. report, for instance, identified 2,300 commercial properties in the Los Angeles area that, if fully utilized for residential purposes, could produce between 72,000 and 113,000 apartments, depending on the mix of unit sizes. This would equate to 9% to 14% of the housing units that Los Angeles County will need to produce by 2030. The report found that adaptive-reuse projects to convert hotel and motel rooms into studio apartments is typically a lower-risk proposition than converting office and retail spaces.

For all the excitement about such projects, however, there isn’t as much activity happening as one might expect. CBRE found that an average of 41 office conversions were completed annually between 2016 and 2022. The real estate services company estimates that the number of projects is expected to double, due to increased incentives and other help from state and local governments.

There are many difficulties for these projects to overcome, but the one aspect that may be insurmountable for many buildings is that the projects don’t tend to pencil out. Most office building conversions are too expensive to make the process financially feasible.

“There’s a lot of ink being spilled on this subject right now,” says Brooks Howell, residential leader and principal at Gensler, a global architecture, design and planning firm. “But the biggest challenge is the major cost mismatch. These buildings are going to have to sell really, really cheaply to make conversions work.”

Howell points to many parts of the building that can be problematic, including the size of the property. The sweet spot for most apartment buildings is about 350,000 square feet, which allows for the greatest efficiency in using all of the space. Larger buildings often need to be mixed-use projects with some floors remaining as office space. This is a problem because, under current circumstances, the office space may not have tenants and would essentially be unused, reducing the value of the building.

But there are many other problems with conversions, from replacing the skin of the structure, to putting in windows that open or adding balconies, which endanger the integrity of the facade. Other than the building itself, there are a variety of zoning regulations that vary from city to city which can upend a project.

There are also mechanical issues. Howell says that some of the reasons that office-to-apartment conversions are so expensive aren’t always the obvious ones. For example, it’s common to single out plumbing and other infrastructure aspects needed for apartments. Howell maintains that plumbing is a set cost and not as much of a problem as the building’s mechanical systems, including heating and air conditioning, which may cost tens of thousands of dollars per apartment unit if upgrades are needed.

“We are in the Wild West with these projects, and developers like predictability and certainty in what they do,” Howell says. “And you’ve introduced more unpredictability and uncertainty in this process. Not a lot of developers are comfortable with that, and I think that’s really what’s slowing the process.”

Due to the added costs, Howell maintains that most, if not all, of the buildings currently being converted are receiving some form of tax credits, usually because the properties are considered historic. It’s the only way for the numbers to make sense. He believes that for more conversions to work, it will require a coordinated effort by federal, state and local governments to develop tax breaks and other forms of financial incentives.

“The federal government is going to have to come up with some plan that allows this process to move quicker,” Howell says. “I’d love to see them step in and incentivize the conversion process. There are many reasons for it, including the fact that converting buildings is the most carbon-neutral way to build housing.

“The question is, how do we overcome all the different roadblocks? There is no coordinated and concerted effort to solve these problems, and there’s not one entity that seems to be in control.” ●

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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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After seemingly endless growth to feed an unquenchable economic hunger for warehouse and distribution space, one of the strongest areas of commercial real estate throughout the COVID-19 pandemic appears to be finally hitting the proverbial wall. According to Cushman & Wakefield’s Q2 2023 national market report on the industrial sector, two years of record-setting demand and cumulative rent growth of 30% has come to an end. Industrial properties, which many had hoped would continue to prop up the troubled commercial real estate industry, are evidently reverting to the norm.

While it may not feel like it, the report points out that demand for industrial space remains historically healthy. Absorption levels in the first half of 2023 were roughly on par with the levels seen in the years leading up to the pandemic.

“If interest rates continue to stay high, I wouldn’t be surprised if 2024 actually ends up with less activity than what we’ve seen this year.”

– Lonnie Hendry Jr., head of commercial real estate and advisory services, Trepp

On the bright side, Southern markets were continuing to expand and accounted for about 61% of total absorption. Savannah, Georgia; Dallas; and Houston led the way as each absorbed more than 3 million square feet (msf) in Q2 2023. A total of 21 U.S. markets posted at least 1 msf of net growth, more evidence of strength for the sector.

Conversely, a sobering figure is that 273 msf of space was delivered during the first six months of the year, but only 116 msf was absorbed. Many more properties are on the way. The industrial construction pipeline declined by 5.1% between the first and second quarters to sit at 624 million square feet of future development, so while construction starts are falling, that’s still a lot of space set to hit the market in the next few years.

Lonnie Hendry Jr., a senior vice president and head of commercial real estate and advisory services for data provider Trepp, isn’t worried. He says the industrial slowdown is part of the natural progression of the sector as it slows from its earlier frenetic pace.

“We are just naturally plateauing from the post-pandemic highs,” Hendry says. “There’s been a lot of new supply added during the past three-plus years, most of which has been absorbed. But if you read the headlines about the sector, Amazon.com has put a pause on any new developments, and they were a primary driver for a lot of the industrial development and absorption. So, I think this is just a natural part of the cycle.”

Trepp doesn’t see anything in its data that shows the sector is in decline or merits overly negative sentiment, Hendry says. Instead, the industry is just at a cooling point. He points out that while many of the properties on hold are the large distribution centers used by Amazon and other major retailers, there is still a lot of interest in Class B warehouses in the right geographic areas where demand is growing, such as the Sun Belt states.

“I think that sector is still on fire,” Hendry says. “Good urban Class B industrial property is hard to come by, so if you have a reasonable clear height and dock-height doors or access points, those properties are still coveted in the market.”

Doug Ressler, manager of business intelligence at commercial real estate research firm Yardi Matrix, agrees that the current slowdown in the industrial sector is about normalization. He argues that there is still a lot of money going into the industrial sector that has yet to be seen in action.

“Everybody wants to put a fork in industrial and be the first ones to call its demise,” Ressler says. “They want to be the first to say, ‘I told you that it was going to heck in a handbasket.’ But really, when you look at the money going into supply chains, we still haven’t seen the money from the CHIPS and Science Act (the $52 billion legislation backed by the Biden administration to support semiconductor manufacturing in the U.S.) reach the economy yet. We haven’t seen the resupplying issue that will bring a lot of money for an improved supply chain and benefit the industrial sector. That may take three to five years.”

Recent troubles with low water levels in the Panama Canal have slowed international trade while raising the prices to import goods. Ressler says that these difficulties could mean further reshoring of industrial production to the U.S., along with rebuilding of the infrastructure for manufacturing and other areas of industrial production.

“(The U.S.) is still late in getting the reshoring effort into gear,” Ressler says. “But once that does kick in, you are going to see that the biggest recipients are the industrial companies.”

In the short term, Hendry says that the health of the industrial sector and the rest of the economy will be tied to the Federal Reserve and its fight with inflation. The industrial sector is likely to continue its cooling trend for at least the first few months of 2024.

“We just haven’t really felt the full impacts of those interest rate hikes that have taken place during the past 18 months,” he says. “If interest rates continue to stay high, I wouldn’t be surprised if 2024 actually ends up with less activity than what we’ve seen this
year.” ●

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In 2006, the median age of a home was 31 years, according to numbers compiled by the National Association of Home Builders (NAHB). The age of existing homes shot up rapidly after the Great Recession.

“Contractors have a tendency of flip-flopping between remodeling and new construction based on what earns them the most money.”

– Todd Tomalak, principal of building products, Zonda

“The housing stock is getting older and the reason is not mysterious,” says Paul Emrath, NAHB’s vice president for survey and housing policy. “We’ve just been building new housing at below-normal rates pretty consistently since about 2008.”

From the 1960s through the 1990s, builders produced about 1.5 million housing units per year. Since the Great Recession, however, they’ve produced far fewer, Emrath says. While home construction activity has risen in recent years, it’s only resulting in about 1.4 million new homes annually, about 100,000 shy of the historic norm. Homebuilders should be churning out even more homes to overcome the existing shortfall and account for population growth, Emrath says.

With fewer new homes coming onto the market, that’s pushed the typical age of an existing home dramatically higher. So, it’s no surprise that the U.S. is in the midst of a remodeling boom. Zonda’s Todd Tomalak says that the years between 2020 and 2030 may well be remembered as “the golden age of remodeling.”

“It’s a number of things that are all coming together at the same time in a way we haven’t seen in the data before,” says Tomalak, the company’s principal of building products.

In addition to aging homes, he also cited other reasons for the remodeling boom. For one, homeowners are sitting on record levels of equity. There’s also the lock-in effect, making owners with low interest rates unwilling to move. Some people purchased rashly during the COVID-19 pandemic and are stuck in homes they dislike. And in the past decade, major remodeling projects per household — as opposed to total dollar volume — were below the levels of previous decades.

Last year, mortgage lenders authorized $275 billion in home equity lines of credit (HELOCs) to U.S. homeowners. That’s the highest total since 2007, says CoreLogic chief economist Selma Hepp. The total amount authorized this year is estimated to decline to $178 billion as higher interest rates deter potential borrowers. Still, homeowners are expected to spend $486 billion on home renovations and repairs this year, the largest amount on record.

“Over the last few years, we’ve seen huge amounts of money spent on improvements and repairs,” Hepp says. “We do believe that number is sort of peaking and will decline slightly from that peak over the next year. Even with that decline, we’re looking at some of the highest levels that we’ve seen since the 1990s.”

Emrath agrees that the number of remodeling projects should decline soon. “It’s been so strong, that was a trend that couldn’t keep going forever,” he says.

Tomalak also believes there will be a lull, noting that homeowners have burned through money saved during the pandemic, credit card balances are rising and higher interest rates are cooling demand for HELOCs. But he thinks that remodeling will pick up after a brief pause and remain elevated through the rest of this decade.

If a homeowner dislikes their property, they can either move or remodel. In the 1990s, homeowners were 4.3 times more likely to move than to remodel, according to census data. By 2021, however, the average homeowner was 1.3 times more likely to move than remodel — a nearly equal likelihood to stay put rather than sell.

Tomalak likens it to holding a beach ball underwater. Without new homes to move into, owners will continue renovating. So, when will it pick up after the lull? “You tell me when rates begin to come back down,” Tomalak says. “If we kind of take what’s in front of us at face value, we would say that we’d begin to see strong growth again in Q4 2024.”

With so much money, labor and materials being spent on home renovations, is this taking away from new construction activity? Tomalak, Emrath and Hepp all say yes to some degree. Hepp cautions that remodeling and new construction activities vary by location.

“New construction is very much concentrated in certain parts of the country such as the Southeast, whereas a lot of renovations and repairs are happening in the parts of the country that are less affordable, where people are sort of sitting in their homes,” she says

Labor is one the biggest issues facing the home construction industry. Tomalak says there are only so many skilled contractors to hire. “Contractors have a tendency of flip-flopping between remodeling and new construction based on what earns them the most money,” he says.

There are lot more remodeling projects than new homes being built, Emrath says. “The typical remodeling project does not use as much labor and materials as new construction,” he notes. “But there are some 10 to 11 million remodeling projects a year compared to 1.5 million new homes being built. Even though there’s fewer laborers, there are more projects.” ●

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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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The recent groundswell for help to control rents has been building for the past few years across the country. According to a 2021 report by the Urban Institute, more than 200 U.S. municipalities have enacted some form of rent regulations, but rent control remains illegal in most states. In 2019, Oregon became the first state to implement a statewide rent-control program.

“If these buildings are regulated to the point of economic ruin, who is going to lend property owners money to keep up the buildings?”

– Michael Tobman, director of membership and communications, Rent Stabilization Association

Some municipalities that have recently joined the movement include Minneapolis and neighboring St. Paul, where voters passed rent-stabilization measures in November 2021. While St. Paul moved forward this year with a modified plan, the Minneapolis City Council has been unable to develop a consensus around its own policies. In March 2023, the Boston City Council passed a rent-stabilization plan that has reportedly run into roadblocks in the Massachusetts Legislature. Seattle officials recently voted down a rent-control proposal but are discussing other options.

Even the Biden administration is getting involved. This past January, federal officials released “The White House Blueprint for a Renters Bill of Rights,” a white paper that lays out a statement of principles that includes renters having access to safe, quality, accessible and affordable housing.

The paper notes that the Federal Housing Finance Agency (FHFA) will increase affordability by classifying certain multifamily loans as “mission driven” if they include covenants that restrict rents at levels affordable to households earning between 80% and 120% of the area median income. This year, the FHFA is requiring at least half of all Freddie Mac and Fannie Mae multifamily loan purchases to be tied to mission-driven properties. If these loans are granted at last year’s rate, this would equate to an investment in 700,000 affordable housing units.

Even if cities continue to fight over the details, it’s easy to see why the recent rent-control push has been so popular. The U.S. has recently seen dizzying increases in rents that far outpace inflation. According to the federal white paper, more than 44 million households — or about 35% of the U.S. population — live in rental housing. These families are facing rents that are rising much faster than incomes. The national median rent jumped by 17.4% during the year ending in January 2022, according to Realtor.com. And renters are demanding relief.

How to get this relief, however, is the subject of much debate. The commercial real estate industry has long held that rent controls don’t work, claiming that they stall new development, reduce supply, lower property values and, over time, harm the local economy. The National Association of Realtors says that while rent control may help some tenants for a short time, these programs increase rents for units outside the controlled area. Developers may be forced to leave an area that has rent controls or turn apartments into condominiums, which exacerbates the shortage of rental units.

Michael Tobman is experiencing the rent-control issue up close. Tobman is the director of membership and communications for the Rent Stabilization Association, an advocacy organization that represents more than 25,000 landlords who own more than 1 million apartments in New York City that are subject to rent-control measures.

Tobman says that rent increases aren’t keeping up with the rising costs of insurance, utilities and property taxes. He maintains that the city’s rent-stabilization program suffers from being politicized and is not means-tested. New York has many examples of wealthy people, even celebrities, living in rent-controlled apartments. One of his main frustrations is that the state’s Supreme Court has determined that rent stabilization is a public benefit. But this public benefit is being provided by private owners.

“Providing affordable housing should be a function of the government,” Tobman says. “And yet the government in New York state has shirked their responsibilities and moved it onto the shoulders of private owners.”

The FHFA recently sent out a request for information concerning the agency’s proposed actions to promote renter protections and limit “egregious rent increases for future investments,” according to the White House. Some 18 real estate trade associations joined together to provide feedback. As expected, the agency got an earful. In a press release, the industry coalition warned that rent-control mandates disincentivize multifamily investments across markets and will exacerbate housing affordability issues, including the fact that supply has not kept pace with the nation’s population growth. Whether coalition efforts can blunt the growing power of the rent-control movement is unclear.

“What we are seeing in certain cities and states is that press-savvy activists have turned this issue into a sort of political organizing cry,” Tobman says. “They are doing this without really discussing the broader economic impact of the policies they are trying to enact. Rent is income from buildings. If these buildings are regulated to the point of economic ruin, who is going to lend property owners money to keep up the buildings?” ●

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