The commercial real estate debt market is firing on all cylinders. Individual property transactions, fueled by low interest rates, have been trending near record levels for the last few months. However, the impressive pace of deal activity following a year of deliberate caution is causing headwinds for commercial real estate lenders. Current staffing shortages, vendor backlogs, and the larger supply chain issues are placing additional stress to closing timelines that lenders routinely met in the past. While it could take time for these issues to iron themselves out, users of acquisition debt are in a tough spot given they’re competing with all-cash buyers in this seller’s market for the best properties.
Borrowers are juggling sellers’ expectations of tighter escrow periods, when in reality, lenders are taking longer to close loans. Pre-pandemic, lenders could close a routine loan within 45 to 60 days, but now, a lot of pieces must fall neatly into place to close within a 60-day window. While many loans encounter unforeseen delays, there are steps lenders can take to shorten the closing process. If a quick closing is essential, a borrower may want to ask a prospective lender about the steps it is taking to expedite the process.
Below are issues contributing to the delays and questions a borrower may want to ask a potential lender to streamline the underwriting and closing processes:
Staffing shortages: Many real estate lenders are understaffed, and it will take some time to hire back qualified real estate professionals and find an equilibrium to handle the increased deal flow. In the meantime, you may wish to inquire if the lender is hiring contractors to outsource the underwriting work.
Third-party reports: Lenders do not allow borrowers to pick their vendors, such as appraisers and environmental consultants. Instead, they are typically selected from a pre-approved vendor list. Because many lenders use the same vendors, there can be a backlog when deal flow spikes. Keep in mind, these same vendors might be experiencing staffing shortages as well. Prior to COVID-19, a normal turnaround time for third-party reports was around three weeks. Now, there are appraisal backlogs as much as six weeks for orders with the large appraisal companies. When picking a lender, a borrower should ask if they have expanded their approved third-party list to include vendors with more manageable turnaround times. Once a borrower has decided to proceed with a lender, an immediate step should be to provide a deposit to the lender so it can immediately order third-party reports.
Title and survey approvals: Unlike the third-party reports above, borrowers manage the title and survey process. Since these are items that the lender’s attorney will want to review, they can require long lead times for approval. Borrowers should order these items very early on in the diligence process.
Property cash-flow underwriting: Having the borrower and lender agree on the property’s proforma cash flow early in the underwriting process is an important milestone. The proforma cash flow determines essential factors, such as loan size and structure (including any necessary reserves) and formulates the covenants that are incorporated into the loan documents. Loan covenants are such a late-stage item in the loan approval process that any delay in incorporating the covenants may cause a hold up in finalizing the loan documents and closing.
Lender loan documents: How thorough are the loan documents? Do they include a 100-page attorney-drafted loan agreement, or are they less exhaustive documents prepared “in-house” using loan documentation software? Private lenders can be more flexible with their loan documentation, while institutional lenders are required to have more belts and suspenders incorporated into their documents. If loan documents require additional reviews from attorneys, it can potentially add a few more days to a closing – not to mention increased costs.
Lender’s capitalization: Does the lender have discretionary authority to fund its loan? Or does it have a capital partner that needs to provide its stamp of approval to fund a loan? Many lenders have arrangements whereby their investors must also provide loan approval before funding takes place. It is good for the borrower to understand the loan-approval process and any implications prior to selecting the lender.
It should be noted there is a niche of private money/hard money lenders that have a very successful business model catering to short-fuse closings, e.g., two weeks or sooner. They can often close on a property without requiring an appraisal or environmental report if they have sufficient information to mitigate the risk, thereby avoiding the current delays of ordering new third-party reports. (A current title report and survey are usually the long lead-time items in these situations). However, the borrower will pay a premium in terms of rate and origination fees for the ability to close in a couple of weeks. For borrowers looking to maximize positive leverage, this route is not accretive to the equity yield.
The hot market should continue well into 2022 partly due to fresh capital entering the space spurred by inflation concerns. Sellers will continue to drive terms and command short escrow periods for top-notch properties. Although the lending industry is currently facing some hurdles to delivering quick closings, keeping the aforementioned points top of mind will help facilitate an efficient closing until the industry right-sizes to handle the extra deal flow.
Rob Murphy is Vice President of Structured Finance and Capital Markets. Based out of Los Angeles, he provides debt and equity placement services for Transwestern’s institutional and corporate clients nationwide.
SEE ALSO:
- Bridge Lending in a Pandemic
- Optimizing Real Estate Sales Through Online Transactions
- The Financing Alternative: Sale-Leasebacks
RELATED TOPICS:
commercial real estate
real estate
structured finance
capital markets
