Financing for Real Estate Investors: Navigating COVID-19

Posted on: May 27th, 2020 by Real Estate Accountants

Last Updated: May 27, 2020

Obtaining financing during the COVID-19 period has become increasingly complex and uncertain for real estate investors. Through discussions with investors and financing professionals, we’ve seen specific trends in the marketplace that real estate investors need to navigate.

Phase 1: Prepare and respond

Initially financial institutions addressed urgent needs with mortgage deferrals and emergency loans, understandably. This forced investors to take a back seat. But now, how can investors begin to address their financing needs? The key is to find the real estate investor-focused financing professionals –that exceptionally small group of people who are able to get results.  Relationships are key.

What’s at stake? COVID-19 has had a devastating impact on many areas of the economy, and real estate investors need to be prepared for further repercussions. For example, we are seeing student rentals in peril as colleges and universities announce online learning for fall semesters.  

Current financing issues

The current environment is creating stress for investors around the following issues:

  • Having to defer debt refinancing as not all banks are processing in a timely fashion for investors
  • Declining valuations as indicated by appraisers and valuators
  • Declining rental incomes as some rent payments become suspect or deferred, decreasing financing opportunities
  • Uncertain job, income, and economic conditions, which will put downward pressure on rental income, while also limiting ability to access financing

Investors who are cash poor, but asset rich, will rely on refinancing to build a war chest to take advantage of opportunities in real estate, stock markets and business acquisitions, or ride out the recovery, however financing delays or denials is limiting this ability.

Add to this scenario weak government support for commercial rent, residential rent support that varies between the provinces and territories but is, generally speaking, relatively minor, and tenant groups that are discouraging tenants from paying rent.

Rent and mortgage deferrals

Mortgage payments and guarantees won’t go away. Mortgages may be deferred, but compound interest is accruing.  However, if tenants defer, they cannot be evicted right now. Likely it will be very challenging to replace commercial tenants in the short-term while many residential tenants may be unable to catch up on deferred rent.

On the positive side, March and April residential rent collections have been very strong so far across the country with May looking good, despite some rents being collected later in the month than normal.  Commercial, however, has been hit and miss.  Many proactive providers are putting significant efforts into communication with tenants, working with them as needed, and finding collections are very close to normal.

However, what happens when the government funding programs end?  What happens as businesses reduce their employees or even stop operating. What will the impact be on rent collections?  On financing opportunities? Time may not be an ally.

Landlords are typically operating on very small margins.  An October 2019 survey indicated that 50% of landlords were cash flow negative. Clearly, cash flow from struggling tenants will provide an additional challenge. The biggest cost, however, may be the inability to manage through recovery and eventual growth opportunities by losing access to financing. 

Financing challenges will not only impact investors. The impact may include declining repairs and maintenance, inability to pay for safety measures, and fewer people who want to build rental units or acquire existing ones to improve tenant conditions. Paying the rent when employment income is reduced is challenging. It is even more challenging for a real estate investor to cover the rent for 10, 20, or 100 plus families.

Phase 2: Recovery

As Warren Buffet notes, when the tide goes out, you see who was swimming naked.  The tide is going out.  Some investors and co-venturers will have different reserves than others.  Some owners will be getting tired and frustrated. Keep in mind this isn’t just relative to investors who may be more aggressively leveraged.  Whether you’re in year 1 or the last year of the amortization schedule, your payments are the same.  If you’re not able to extract some equity to buy some time and comfort, you may be in trouble.

Keys to remember

Some interesting points to consider as you move through recovery phases that I have picked up in speaking with financing professionals from both the big banks and boutique mortgage brokerages:

  • Relationships are critical. A senior individual at one of the big five banks emphasized how important it is to have a relationship with the bank. They were not interested in starting a new business relationship until at least the fall, unless through a very warm introduction. On the construction side, they really were not looking for additional business at this time. They are looking to push out deals as long as possible to receive more comfort regarding valuation.
  • Take caution with mortgage deferrals. Initially, the message was that the deferral is not an issue for credit.  But, we’ve now heard several stories about mortgage deferrals interfering with deals, including:
    • Affidavits being sworn at closing that none of the investors had requested a deferral, or the deal would collapse  
    • A closing falling through because the guarantors – the parents of the purchasers – had asked for a deferral
  • Borrowing minimums. It is my understanding that, practically speaking, minimum borrowings of $5 million are needed to get a commercial product placed in a bond offering.  Otherwise, there is little interest in doing the work.  This can be attractive for medium-sized investors – one example was less than 2% interest for a 10 year term.  It might be time to consider grouping some properties and putting a blanket mortgage on them.
  • Mixed messages on new deals. Some real estate groups in national banks are very open for business, but many I have spoken to have been much more reserved in their appetites for new deals.
  • Expect a lot more due diligence. For example, one of the deals I was involved with wanted to know the address of the settlor of a family trust created years ago. In a number of cases the current address tends to be a cemetery. 

Phase 3: Growth…

I believe that many opportunities will exist for real estate investors who can survive the next 6 to 24 months.  Good investors will create win-win relationships.  The challenge will be in obtaining financing acceptable to the financial institution and with right terms and timelines for the real estate investor. 

George E. Dube, CPA, CA
Tax Partner, Real Estate and Construction Industry, BDO Canada

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