Where We Are and Where Are We Going!
Welcome to our re-cap of our presentation and learn our insights about borrowing money, what you need to know as a private lender, or things to be aware of before borrowing from a commercial lender in 2022.
We need to have an understanding of both the prime and treasury historic rates to gain a perspective for 2022.
When looking at the past 22 years, we are actually not at the highest interest rate. Treasury rates are used to indicate various aspects of our economy. Over the past 22 years the 10yr and 20yr Treasury Bond rates have fluctuated with small gains or reductions over short periods of time. The last time the Treasury rates increased anywhere near as much as they have in the past few months was between mid-2011 to early 2013. Today’s increase is similar but has been brought on by the Federal Reserve Bank reigning the economy in, attempting to keep inflation in check.
Low Unemployment has complicated this movement by the Fed. Unemployment and high inflation were last in the early 50’s almost 70 years ago. The concern is while the job market is extremely tight that higher wages will be a result of this tightened market thereby fueling inflation at the consumer level even more. Remember, the Fed is trying to tighten the money supply by raising interest rates. By doing so, historically, the economy shrinks and unemployment rises.
Former U.S. Treasury Secretary Lawrence Summers has noted that every time inflation has exceeded 4% while unemployment was below 5% over the past 75 years—which has happened in 70 months—the U.S. has fallen into a recession within two years.
The most recent of these events is from May to June of 2006, which was followed by the financial crisis starting in December of 2007.
Fed Chair Jerome Powell said in an interview with Marketplace that he couldn’t promise a so-called soft landing for the economy where inflation gets back to the 2% range and the labor market remains strong. “It’s quite challenging to accomplish that right now,” he said. (source, Barron’s, 5/25/2022)
Bond Yield Curves – Direction of Economy can be forecast through the observation of the US Treasury Yield Curves. In this graph, the curves from the bottom, represent the yield curves by the months for 2022. The economy has gone from being reasonably robust for the first quarter of the year to pointing toward a future recession. The indicator of the recession is how the curve flattens in April (Gold line) to this past Friday (dark blue line). Economists state that when the yield of the shorter term instruments, in this case the 2-year rate, is nearing the same rate as the 10yr rate, then the economy is headed towards a recession.
Sample Institutional Lender Rates – This is one of many lenders working in the 30yr Fixed Mortgage market. They are somewhat tied to the 10yr Treasury Bill. As can be seen the long term rates are rising much as the consumer mortgage rates are. What is of interest is how they perceived and mitigated their risk in this market over the past 2 years.
During the pandemic the average spread between the 10yr Bill and their mortgage was hovering around 2.9%.
As the effects of the pandemic were dropping, along with all of the government rent and mortgage freeze programs, they lowered their spread to approximately 1.9%, a full 100 basis points from the 2020 spread.
As inflation worries started showing up in their data analysis in early 2022 risk abatement was once again put in place with a hefty increase of 140 basis points to the current 3.4% spread, we see today.
In the Multifamily lending space, we are seeing an increase in the spread between the T-Bill rate and the final interest rate to the borrower. The delta between the 5yr spread and the 10yr spread has remained pretty much the same throughout the year. What has happened to mitigate the risk involved is the actual spread for each of these loans between the T-Bill and final rate has increased by 15+/- basis points. This increase along with the increase in the T-Bill rates has pushed the final interest rates for a 10yr Tier 2 loan to about 5.68%.
The Secured Overnight Financing RATE, SOFR, has held steady at 0.05% up till March 16 of this year. This coincides with the first FED rate increase. The SOFR is an index of what banks charge during the overnight transfer of money among various institutions. It has increase 6,800% over a year ago.
Some lenders have switched their use from the LIBOR rate to the SOFR rate. The spreads used are similar to either index but as with any loan the spread is what makes or breaks the deal. One lender that was interviewed has stated their bridge loan products have a spread between 350 to 450 basis points. At the high end for this lender their bridge products now range between 4.20% to 5.20% based on the SOFR of June 15, 2022. These are for loans originating at the level of $15M and above.
Commercial lenders are pushing the limits of controlling their risk thru a number of methods.
Qualifying FICO Scores have increased from an average of 640 to 660. In order to obtain the best rates the FICO scores have increased from 740 to 780.
Lenders are discounting professional appraisals. Most recently I have experienced from 2 different lenders discounts of 20%-25% of the appraiser opinion of value. Requesting data to support their claims apparently is futile.
If the project has a Value Add component upwards of $100,000 or more then the borrower should be prepared to either prepare and or have a Feasibility Study performed by a third party construction management organization in order to satisfy the lender’s risk concerns.
Guarantors – This has had minor changes but the members of an entity that have a 20% or greater ownership share should be ready to have their finances reviewed, even if they are on the sidelines with the strongest person as the guarantor.
Tax Returns for the guarantor(s). Depending on the structure of the ownership, other members/owners may need to share their tax returns as well.
Property requirements are tightening to some degree. Regardless of the type of loan, Purchase or Refinance, the following items should always be made available to the lender:
- P&L Statement from Previous Owner (if a purchase)
- Balance Sheet from Previous Owner (if a purchase)
- Rent Roll showing rents for the past 12 months
- Lease Agreement(s)
- Business Tax Returns
- Environmental Report may be Required More Often than Not
- Property Tax Statements
- Insurance Coverage
- Exit Strategy Statement
- Based on the Yield Curves we have a reasonably good probability of a recession in the next 12-24 months.
- This conclusion is bolstered by the combination of inflation being higher than un-employment. Historically, when these two indicators are inverted there has been a recession with in 2years.
- The question is: How long will a recession last. A recent Reuters article quotes James Gorman, CEO of Morgan Stanley, stating, “There is a 50% chance the U.S. economy will enter a recession though any downturn is unlikely to be severe.”
- During these tough financial times and in to the foreseeable future, putting together and pushing a commercial loan thru to close will involve having lower LTV to meet the requirements of the DSCR for any given loan. As the interest rates increase the only factor that can be adjusted to meet the DSCR requirements will be an increase in the borrower’s equity position, hence lower LTV.
- Putting together and pushing a commercial loan thru to close will take more time, effort, documentation and patience.
Some of our lenders will work with the following background issues:
- Litigation with another Lender
- Bankruptcy (10yr lookback)
- Foreclosures (since 2012)
- Delinquency with suppliers
- Outstanding RE Liens
- RE Loan Delinquency
Our lenders are ready to work with contractors and investors. Now is a good time to buy a distressed property but be aware of the risks and understand what you’re getting into. Distressed homes offer a unique buying opportunity for real estate investors, but the average home buyer should probably look elsewhere.
If you need funding, apply now. I am working online with the rest of you.
Patrick St. Cin
W – 512-213-2271