HOT TOPICS IN COMMERCIAL LENDING
Julie Novak, Senior VP at BankCherokee, and John Young, VP Paramount Real Estate, recently talked about many of the hot topics in commercial lending. See below to read more about how banks are working with clients during Covid, the future of interest rates, underwriting standards and more.
John: “Tell us about yourself and BankCherokee.”
Julie: “I’m Julie Novak and I am a Senior Vice President with BankCherokee. I’ve been here going on eight years and I’ve always worked in community banking by choice. I just really feel strongly about community banks and being able to develop relationships and work closely in those communities where we live and work. Bank Cherokee is a 100-year-old family-owned, woman-led banking institution and is the oldest family-owned bank in the metro area. Our President and CEO, Heidi Gesell, has led the bank since 1996. Our goal is to help small and mid-range businesses with all their banking needs. We’re a preferred SBA lender, and we do a lot of commercial and industrial lending as well as real estate lending”
John “How many locations do you have?”
Julie: “We have currently four locations around the metro area.”
John: “How has the last year affected your clients?”
Julie: “I have been in banking for a long time, and in 2020 with the pandemic and PPP loans, it has never been a more challenging or rewarding time to be a banker. If you’re a liquor store, then it has been like Christmas every day, but a lot of other businesses have not been nearly as fortunate. Despite all of the challenges of the last year, we see a lot of opportunity ahead and I think business owners, who are entrepreneurs by nature, they’re always going to be optimistic and very resourceful. Technology is playing a huge role in business success and we see our clients investing in technology to make them more efficient. Certain aspects of business operations will not go back to the way they were and that’s okay. I really think businesses have learned to pivot and some changes they’ve had to make will probably end up being a permanent change going forward.
John: “There is a lot of talk about interest rates increasing, what do you think?”
Julie: “We’re of the opinion based on what we see that rates will continue ticking up bit by bit, and I think that that’s going to be the trend. They have been so low for so long that I think there will be incremental increases over time. But there is still wide-open opportunity to take advantage of low interest rates to purchase that building, buy that equipment, hire employees – there really is a long runway for more investment in businesses. We are very bullish on the future for business”
John: “Do you see a return to double digit interest rates?”
Julie: “Not anytime soon, that’s for sure. With all the indicators that we are seeing, no.”
John: “Given the changes over the last year, have your underwriting standards changed for approving loans?”
Julie: “Yes and no. We really want to look at what a company’s Covid business plan is, and I don’t mean having hand sanitizers in the lobby. We want to know ‘how have you weathered 2020 and how are you planning to weather 2021 and beyond?’ Big questions we want to explore are: are there changes in your staffing, are there changes in your clients as you may not have the same ones as in 2019/2020, how has your supply chain been affected, and any other changes to the operation over the last year. At the same time, we know that the last year has affected every business in a different way. So, we want to understand what you have already done, what you are planning to do, and then we work with each customer and support them through this.”
John: “So, if a business is thinking about buying a building, what specific steps should they take to prepare for that process? Do you have some recommendations on specific things they should do start to do?”
Julie: “Yes, absolutely, they have options because you don’t have to come up necessarily these days with a 25% down payment. An SBA 504 loan may be an excellent option which requires only 10% down. My advice is to have them call their professional contacts. Get a good broker who can help you with the transaction, get a good accountant, you want to get somebody that’s really going to help you get your numbers pulled together. We will want both historical numbers and projections. You certainly need an attorney at some point too so knowing those key people can really help any business put it together.”
John: “What changes have you seen in appraisals in the last year through Covid?
Julie: “An appraiser once told me, it’s an art not a science, which leaves the door open as to interpretation of the property value. We have seen appraisers getting more comfortable with where things are currently at, turnaround times have been good, and I think appraised values of commercial property are coming back to levels it had been pre-pandemic.
John: “With the rise of the internet there has been a rise of online banking. You can get a loan on the internet very quickly, why has that become so attractive?”
Julie: “It’s perceived as an easy way to get money, and it is, until you want to unwind it and that is where the challenges begin. Sure, you may get the money you need, but it is a higher interest rate, shorter loan term, online lenders won’t usually work with you if there is an unexpected challenge, and you don’t have the support and service that you will receive at a bank.
John: “What’s the timeline typically for getting a loan approved to buy a building?”
Julie: “If the borrower has everything in place and if we have the documentation ready to go, we can approve and close a loan in three to four weeks. We will need to wait for the appraisal and environmental to be completed also. So, our process internally can be relatively quick, but some of these other variables take more time. Appraisals have been taking three to four weeks and environmental testing can sometimes take even longer. We are doing our work at the bank behind the scenes while all of the other external work is happening so we are ready to close as soon as possible.
John: “What are you seeing with environmental issues these days?”
Julie: “Vapor intrusion has been the hot button the last couple of years, and I think it will continue to be. The good news is that sellers have been providing an escrow from sales proceeds to help buyers pay for vapor mitigation systems. We have become accustomed to working with environmental issues because it is quite prevalent in commercial and industrial properties.
John: “Is there anything else you would like to add?”
Julie: “BankCherokee is a local community bank and we have all the tools that large banks have. That’s a beautiful thing to be smaller, more nimble, AND have all of the right tools for businesses. We are able to think outside the box and are not beholden to somebody in another state, but instead have all of our decisions made right here in St. Paul.
HOT TOPICS IN COMMERCIAL LENDING
MID-YEAR 2020 INDUSTRIAL MARKET UPDATE
Net Absorption & Vacancy Rates
Statistically, Q2 2020 is showing the effects of COVID-19 on industrial leasing activity and the industrial market. Net absorption of vacant space during Q2 2020 was only 107,345 SF compared to 829,298 SF for Q2 2019. YTD net absorption for 2020 totals 330,369 SF compared to 1,587,669 SF in 2019.
The difference in the net absorption numbers (SF) between 2019 and 2020 is significant. However, the industrial market remains healthy as demonstrated by the overall industrial vacancy rate of 5.0% through the Q2 2019 and 4.8% through Q2 2020. More specifically, YTD industrial vacancy rates reflect the continued sound condition of the market by product type:
What is Influencing this Market Condition?
Two characteristics of the current market have significantly influenced the ongoing strong conditions of the industrial market: 1) Vacancy rates were at historical lows prior to the introduction of COVID-19 and, 2) Delivery of new industrial product to the market year-over-year has moderated. YTD Q2 2019 deliveries of new industrial product totaled 1,853,203 SF. While Q2 2020 new deliveries of industrial product totaled only 906,571 SF. The combination of less new development coming on line and limited negative absorption has enabled vacancy rates to remain low. Therefore, the overall market is in a state of good health.
Current expectations between landlords and tenants do seem to significantly differ. Tenants believe the industrial market has weakened and landlords are still very bullish on the market. A major reason for this difference in perception of the market has been the media’s reporting on the commercial real estate market. Retail and office space have been significantly impacted by COVID-19, so far in 2020. COVID-19 has had a very limited impact on new industrial lease terms and conditions, at least through Q2 2020. Limited net free rent, and tenant improvement packages, combined with strong net rates seems to be the story of the day for most industrial properties. The one exception to these healthy characteristics is office/flex/showroom product. Office/flex/showroom product still requires net free rent and significant improvement dollars generally to consume a new lease.
Hottest Industrial Market Segment
One of the brightest spots in the industrial market is User/Owner building sales. The limited supply of functional industrial properties currently available For Sale, combined with the low interest rate environment for debt, has pushed User/Owner building values to all time highs. Specifically, well-located properties receive multiple offers in many instances.
What is to Come
Finally, finding a vaccine that will make the current pandemic a thing of the past will remove much of the uncertainty existing today in the economy and the commercial/industrial real estate market. If the pandemic continues on into next year, the statistics and resulting story being told may be much different than it is today.
Written by: Phil Simonet, Principal
Is This 2008 All Over Again?
Industrial Building Values
Even in the best economies, owners are curious about the value of their building. In times of economic uncertainty, this question takes on even more significance. For many business owners, this recession may be forcing them to ask the tough questions related to building values. The short answer is that buildings are not worth what they were 60-days ago. Beyond that, future predictions require a well-informed analysis.
First, a bit of history. The 2008 Great Recession eliminated most of the demand for industrial space, both for lease and for sale; however, the supply of available buildings did not change significantly. This supply and demand imbalance created a significant drop in building sale prices that was at times up to 33%. Contrasted with today’s environment, the low supply of available buildings has pushed prices to unheard of levels. In fact, some high-quality owner-user buildings were selling for $100 per square foot or more, an all-time high in the Twin Cities. The current crisis will certainly reduce demand for buildings, which is already becoming obvious through terminated purchase agreements, fewer showings, fewer offers, and reduced offer prices.
Naturally, values must come down, but will they drop precipitously like they did in 2008? Probably not. And here are a few reasons why:
#1: Some industrial companies are thriving which will preserve some demand for industrial buildings
For example, clothing manufacturers are now making masks, plastic extruders are now making partitions for retail stores, medical manufactures are now making face shields, and the list goes on. This is different than 2008. During that crisis, it was hard to find any thriving industrial business that still wanted to buy real estate.
#2: Banks are still lending and interest rates for owner-users are exceptionally low
For example, the SBA 504 rate is currently 2% over the 5-year Treasury bill, which is under 1%. Bank interest rates are also 1-2% lower than before the crises. This lower cost of capital will help those who are thriving to borrow money for real estate.
#3: There is pent up demand
Many companies have been searching for the right building to buy for years. Because supply has been so low, these companies have lost out in multiple-offer situations and because many buildings traded immediately when hitting the public market. Many of these would-be buyers are still healthy and able to jump on the right opportunity when it appears.
So, back to the original question, what is the value of your industrial building today? Recent reductions in list prices and re-trading of existing deals indicates that values have declined by 10%-20%. A more accurate analysis is to look at values over time. Down 10%-20% today; however, if the drop-off in economic activity continues, values could continue to fall. A resurgence of Covid-19 could create the dreaded “W” recession, and another dip in economic activity and value. If the economy is opened for business soon and can get back to a more normal level of activity, values may stabilize and begin to rise as we all get back to work.
Stay tuned for more analysis as events unfold over the next few months.
Minnesota COVID-19 Resources for Businesses
Call John Young
Is This 2008 All Over Again?
Is this 2008 all over again? The answer is “maybe”, but “probably not”. Let’s go back in time. The 2008 Great Recession started with cash being drained from the monetary system. This was due to a massive failure of collateralized debt obligations held by the largest banks and over-building in the housing sector. This created a liquidity trap where Federal Reserve monetary policy was ineffective. Interest interest rates were already low and consumers were holding cash. There have been three notable liquidity traps in recent history: post-depression 1930’s America; Japan’s mid-1990’s recession; and most of the world after the 2008 great recession.
Although we have not had the customary two quarters of negative GDP, most economists are saying we are now in a recession. However, this one did not begin with the same cash drain as the 2008 crises, but is it creating the same liquidity trap? Not exactly.
This recession started with sharply reduced demand due to social distancing/quarantining and subsequent job losses. It did not start with cash being drained from the worldwide banking system. To date, almost 10 million Americans have filed for unemployment and, according to Goldman Sachs, the U.S could lose 37% of its GDP, the largest hit to GDP in history.
What is the main difference between 2008 and now? The $2.0 trillion fiscal stimulus bill is more than twice the size of the stimulus bill in 2009. It is focused on both businesses and consumers including a $1,200 direct payment for most Americans. In other words, there is far more fiscal stimulus pouring into the economy meant to save businesses and maintain some amount of consumer demand.
How bad will it get? Let’s think about a few important questions:
QUESTION #1: When will this current economic downturn end?
Answer: If the epidemiological models are correct, sometime in June or July we may get back to our near normal routines.
QUESTION #2: How much injury will be done to businesses and consumers?
Answer: It depends on how much cash businesses or consumers started with. If businesses and consumers have enough cash to pay rent, mortgages, and basic needs, then maybe there will be pent up demand and we can take off quickly. On the other hand, if working capital, credit cards, and other loans are already maxed out and cash is low, then a period of months (6-12 months????) may be necessary for the economy to come out of this recession.
QUESTION #3: Will the Fed, U.S. House and Senate be effective in combating this recession?
Answer: Yes, so far. They are bringing out the big guns with both fiscal stimulus and monetary policy.
QUESTION #4: Will there be an inflation hangover from all this borrowing?
Answer: Many economists are saying, “no”. Primarily because the U.S. is borrowing money at a negative real interest rate, and technology and innovation have kept inflation low since 2008, a trend that will probably continue. For example, we are all working from home now and most businesses will learn, just like 2008, that they can do more with fewer people and smaller real estate footprints. These factors, among others, should keep the inflation-making prices and wages mix under control.
One thing is certain, we all need to buckle up for a rough few months and cross our fingers that businesses and consumers are ready to spring into action very soon.
Minnesota COVID-19 Resources for Businesses
AJ Chivetta doesn’t hesitate: Crowdfunding is changing the way people can invest in commercial real estate. And because of this, the number of people investing in commercial real estate through crowdfunding will only grow in the coming years, he said.
Chivetta should know. He’s a founder and chief executive officer of Selequity, a St. Louis-based company that helps investors place their dollars in commercial real estate properties across the country. He’s seen up-close just how eager consumers are to invest in commercial real estate properties that were formerly out of their reach.
“Crowdfunding solves problems for both sides of the commercial real estate transaction,” Chivetta said. “Investors are looking for opportunities to invest in real estate. They are looking for the kind of yields that real estate has long afforded people, especially in low-interest-rate environments. Real estate owners and operators are always looking for new investors and capital.
“With crowdfunding, more investors can gain access to commercial real estate, and owners can attract capital from a greater number of people,” Chivetta said.
Continue reading Commercial real estate crowdfunding is here to stay, say the industry’s pioneers.
Written by Dan Rafter, REJournal.com.
The Fed decided to maintain the current level of interest rates at 0.25 to 0.50 percent, following the two-day discussion of economic outlook both globally and in the United States. The Fed also reiterated that the federal funds rate should increase “gradually,” proving those in the commercial real estate industry who expected four interest rate hikes this year wrong.
According to Fed Chair Janet Yellen, “The median projection for the federal funds rate rises only gradually, to 9/10th of a percent late this year, and 1.9 percent next year. As the factors restraining economic growth are projected to fade further over time, the median rate rises to 3.0 percent by the end of 2018, close to its longer run normal level. Compared with projections made in December, the median path is about one-half percentage point lower this year and next. The median longer run normal federal funds rate has been revised down as well.” Continue reading Fed Rate Decision Welcome News for CRE Borrowers.
Written by Diana Bell.