by Ray Sturm and Ryan Craft

Uncertainty during personal and economic danger is hard to endure. However, in the weeks and months ahead lenders and investors alike will be forced to make decisions with incomplete information. In times like these, with the ongoing spread of COVID-19 and the incredible speed at which things are changing around us, the difference between businesses that succeed and those that fail often comes down to flexibility and access to the most current information. To support our community, we wanted to share what we’ve learned in discussions with lenders, REITs, and asset managers.

REIT Equity Plunge: Mortgage REITs (mREIT) play a significant role in Private Lending and almost all non-bank real estate lending. REITs are funded by bank lending lines and as asset values fall, they come under margin call pressure. Over the past two weeks, we have seen five public REITs announce that they cannot meet margin calls and all are hoping to negotiate forbearance.  REITs are in survival mode. They are not looking to buy newly originated loans, ut rather are looking to sell.  Other mortgage credit investors have been taking cues from the REIT sector, worrying about further selling pressure and the supply of assets that need to be sold.  The Federal Reserve is rumored to be adding non-agency assets to their liquidity programs, and until then this sector remains on watch and unlikely to aggressively re-engage with purchases. A great “risk on” signal will be a Fed program, REITs rallying, and buyers back in the market.

Lender Feedback: Lenders are following past credit crunch playbooks and tightening guidelines while focusing on their strongest borrowers.  We expect:

1. Rates to increase 200-300bps for even the best borrowers
2. An immediate 10-15% drop in maximum LTC/LTV, and
3. An increase around minimum experience hurdles.

Loans will continue to get done, but at lower leverage and higher rates. We’ll likely experience a medium-term drop in origination volume and a rise in defaults and workouts. Loan maturities will be extended and construction timelines will grow, so lenders should be increasing liquidity wherever possible. All parties will probably need to compromise; lenders, banks and warehouse providers all know that no one wins if you have a portfolio full of half-finished homes on the line.

Market Outlook:  The market is ultimately looking for progress on stopping the spread of the virus. The timeline around businesses re-opening, along with consumers earning and spending money, is still difficult to decipher. Until that path solidifies, real estate lending markets will be challenged. Once we see true price discovery after a slowdown in the spread of the virus, the capital markets should open back up and begin to return to recent form.

As a whole, the underlying housing fundamentals in this country  — aging housing stock, a massive undersupply of new housing, and a Millennial generation literally coming out of quarantine in city apartments into all-time low mortgage rates  — remain strong. On the other side of this “curve” will be a strong demand for housing and a structural shortage of homes. Our borrowers will be the main buyers of real estate while the market is rocky and will be able to find great investment opportunities. The bottom line is that the private lending industry is more important than ever, and it’s up to us to adapt and take full advantage of what’s ahead.

Ray Sturm is the founder and CEO of AlphaFlow, a capital partner to private real estate lenders. Ryan Craft is the founder and CEO of Saluda Grade, a boutique advisory firm focused exclusively on the Private and Alternative Lending sector.