HREC’s Flynn Discusses Impact of COVID Recession on Multifamily Lending
By Dennis Kaiser
As CEO of Hunt Real Estate Capital (HREC) and ORIX Real Estate Capital (OREC), James P. Flynn is excellently positioned to assess the current lending environment for CRE investors as the world continues to feel the disruptive impacts of the COVID-19 pandemic. HREC and legacy OREC brands RED Capital Group and Lancaster Pollard – currently in the process of merging into a singular entity under Flynn’s leadership – have structured more than $130 billion in loans and currently maintain a servicing portfolio of more than $40 billion.
For our latest CRE Q&A, Connect Media asked Flynn to outline some of the biggest challenges the multifamily market faces, explain changes in underwriting, and briefly touch on the GSE response and its implications for borrowers. Flynn will participate in Connect Media’s Special Multifamily May Market Update Webinar tomorrow (May 12), which will be available to watch on our CRE news site.
Q: What are the biggest challenges the multifamily sector faces in the COVID-19 era?
A: The depth and duration of the COVID-related recession and its impact on the ability of tenants to remit timely rent payments represents the principal threat to owners. In the short term, owners seem to be relatively insulated from this issue. More than 90% of apartment renters remitted rent payments for April, and stimulus payments and expanded unemployment benefits should enable most tenants to remain current through June or longer.
Should economies remain shuttered into the summer months, however, cash flow risks will rise. State unemployment insurance pools are already experiencing reserve issues and cannot maintain current payment levels for more than a few months. Further federal support in the event of state benefit shortfalls is likely, but its timing and magnitude are uncertain.
Investors with properties in cities that rely heavily on sectors that have been hardest hit by the crisis — hospitality, energy, and transportation, for instance — will face additional challenges. For example, many of the most affected markets (Houston, Las Vegas, Orlando) also have active construction pipelines. Under the circumstances, lease-up periods may be extended, and owners of currently stabilized assets could face considerable challenges to maintain occupancy at economically adequate rents.
Property-level safety issues are another challenge, but one in which tenants’ and owners’ interests are aligned. Enhanced cleaning and maintenance schedules, sanitary food and package delivery policies, PPE and other support for tenants working from home, as well as clear procedures to maintain social distancing protocols will protect tenants while solidifying bonds between tenants and property management. This may improve collections in the near term and should elevate tenant retention rates over the long haul.
Q: Has the COVID-19 pandemic changed the pace of deals?
A: Not in any fundamental way – yet. We continue to move deals from application to closing even as we set up home offices. It helps that we have a talented group of experienced professionals who have been through the last recession. Our clients can rely on us for guidance, and our track record is a big plus in moving deals forward.
Our partners at Fannie Mae, Freddie Mac, and HUD/FHA have also done a fantastic job adjusting and communicating changes to their loan programs. They have made it clear that they are in business. It may take a little longer to complete a deal, but they are getting them done.
The big question for the second half of the year is not whether we can close loans for our clients, but what is the pace of transaction volume in the market as a whole.
Q: What has been the response from GSEs? Are they reducing allocations or changing lending criteria?
A: Fannie, Freddie, and FHA have successfully taken their operations online and are formulating policies to carry our borrower network and our nation’s renters through this crisis. All three organizations have issued detailed underwriting guidance and, over the last few weeks, asked for additional reserves for loans going forward. We anticipate ongoing guidance from the agencies as they refine their tactics, and we will continue to make whatever modifications to our underwriting requirements that are necessary, and do so as expeditiously as possible. The agencies have been holding numerous calls with lenders for input into what is working and what is not, and where we collectively need to address issues.
Q: What does it take to secure funding today?
A: The financing environment is highly deal-specific at present. Each loan is being evaluated on a case-by-case basis.
Given the current economic uncertainty and the public health risks, there is additional scrutiny on all transactions. The industry is being more conservative in response to various credit risks, such as non-local borrowers, negative credit history, commercial space, cash-out refinancing, specific market risks, or any other deal-specific concerns. In addition, with respect to collections, we are giving more weight to the most recent months.
For cash-out refinances, expect to see an increase in the required debt service coverage ratio (DSCR) and/or a reduction in LTV. While the circumstances of each transaction will be different, a well-developed and documented response plan detailing precautionary and reactionary measures will be viewed positively by the GSEs.
For comments, questions or concerns, please contact Dennis Kaiser