Sara Havlena
Office will continue to be one of the least preferred property types over the next year due to the uncertainty associated with the impact of the pandemic on tenant occupancy. CMBS lenders who are typically a strong option have not been as active, while many of the large money-center banks have pulled out of the space because of the risk. Turnaround opportunities or speculative deals will be harder to finance. The current uncertainty in returns makes these deals hard to underwrite. Do not expect lenders to offer many cash-out loans any time soon. Deals coming off of cheap loans will be tough to refinance and will need additional equity. Lenders will prefer borrowers bring fresh equity to the deal. Lenders will lower LTV maximums and underwriting will be tighter. Borrowers will see 50% to 65% leverage on first mortgages, with most lenders preferring a 55% maximum. Mezz debt could get up to 75% to 80% with a strong story. Rates will be in the 5.5% to 6.5% range. Debt yield will be 9% to 13% depending on the risk.
Banks including Bank OZK, CIBC, HomeStreet Bank, Fifth Third Bank, Associated Bank, Union Bank and TriState Capital Bank will consider office deals. Fidelity Bank and Washington Trust will fund medical office buildings. Expect banks to be long-term relationship oriented and become more creative on deals that require structuring such as earnouts for improved property performance. Banks will want to be confident the deal will work at a 5.5% to 6% rate to ensure they have an underwriting cushion. Count on banks to stretch on deal terms if there is a depository relationship.
Life companies such as John Hancock, Securian, Aegon, Nuveen, ReCap (RGA Reinsurance Group of America), Allianz Real Estate, Lincoln Financial Group, CUNA Mutual Group, RiverSource Life Insurance Company, StanCorp Mortgage Investors, Security National Commercial Capital, Farm Bureau Insurance and GPM Life Insurance will fund deals.
Look for lenders to underwrite higher vacancies and there will be extra scrutiny on the tenant roster. Lenders do not know how to underwrite leases or future rents until more data points are available. Higher vacancy assumptions are being applied and cap rates are rising slightly on all but the long-term credit deals. Leases are being scrutinized more closely for early termination options and the length of the notice period must be provided for tenants exercising any renewal options.
High-quality newer properties with favorable access and high traffic counts will be targeted. Hospital-affiliated medical office or long-term credit-tenant lease deals will see the most available capital. Count on a preference for a diversified tenant base with maturities spread out evenly over the loan term. A diversification among tenant industries will also be sought after.
Single-tenant deals with short-term lease maturity or in an industry with lots of consolidation taking place are challenging to finance without strong sponsor guarantees. High-rise office buildings will also be tough to finance. The location will be more important than ever since markets such as San Diego are actually seeing some recovery versus harder hit areas such as San Francisco and New York City. Cities with strong employment centers and population growth, including Phoenix, South Florida, Nashville, Tenn., Charlotte and Raleigh, N.C., will be sought after. Count on lenders to be worried about physical occupancy of the building, as empty buildings are harder to re-tenant.
Net worth and liquidity requirements are getting tougher. Lenders will spend more time analyzing portfolio risk for the larger landlords. Lenders will look closely at borrower experience and want to know if they will be able to re-lease any vacant space. Undercapitalized borrowers will not find available financing. Borrowers need to show past experience on repositioning deals; lenders will want to be confident they can manage the timeline and any budget issues.
