History has repeatedly proven that private money lending thrives during economic downturns. With the arrival of Covid-19, we began to experience unprecedented, widespread economic effects. There has been a continual tightening of standards in the conventional lending space. This is common during times of crisis. What always happens during cycles when conventional lending opportunities contract, private lending expands, and both borrowers and private lenders alike start seeking out new opportunities.
However, the private lending niche has not been fully immune from the damage caused by the severe economic impact of COVID-19. Some private lenders and capital providers have either temporarily or permanently shuttered their operations due to a freeze of their capital sources, poor underwriting practices, and/or non-performing loans, resulting from a coronavirus-related forbearance or default.
For private lenders who are fortunate enough to still be actively lending today, there are market delays stemming from rate renegotiations, expanded due diligence, short-term extensions on maturing debt, and the re-underwriting of loans. In addition, since unfortunately private money tends to be the choice of last resort, there’s the perennial shopping of the borrower market by traditional lenders, who try to convince borrowers that traditional loans are preferable.
In the following text, The Rules of Thumb blog from MoneyThumb will help our readers understand more about what is happening in the current private lending sphere, and how private lenders are dealing with the financial landscape caused by the pandemic. We will also discuss how the private lending underwriting process has been impacted by Covid-19 and how these current financial times are to the advantage of the private lending market.
Private lenders are approaching challenges in new and different ways. Some private lenders are pressing the pause button to focus on managing their existing portfolios and negotiating workouts on any non-performing loans. Others are actively transacting, but they are implementing modifications to their existing guidelines. Today’s “new normal” in private lending, especially when it comes to real estate transactions, may include all or a combination of the following:
- Price increases
- Reduced loan-to-value thresholds
- Removal of vulnerable property types, such as retail and hospitality from their pipelines
- Reduced or eliminated subordinate financing
- Requiring or increasing interest reserves
- Applying full recourse in instances where non-recourse was the normal
There are some private lenders who are choosing to not make any changes. They continue with a business as usual mentality, enduring the delays and disruption, and not adjusting for any perceived new market risks.
The Pandemic Impact on Underwriting
The pandemic has put everything to the test, including the private lending underwriting process. However, many private lenders aren’t standing by to see what is going to happen. Rather, they are adjusting their methods and underwriting standards to ensure that there is ample equity coverage to account for the new economic, political, and societal stresses.
These risk-based adjustments include, singularly or in combination:
- A blanket 20% discount on pre-COVID-19 values as a basis for as-is valuation
- Increasing underwriting assumptions, including vacancy rates and expense ratios
- Making cap rate adjustments
How long these pandemic-induced changes to underwriting practices and lending guidelines will continue remains to be seen.
How The Pandemic Is Causing Private Lenders to Flourish
Unlike traditional lenders who are hampered by the burdens of federal regulations, private lenders are nimble and can pivot to meet a range of market demands and unique circumstances. Whether a borrower is seeking speed of execution, a short-term bridge to traditional financing, creative loan terms, or a solution for personal hurdles, such as foreign national status, limited liquidity, bankruptcy, or a low credit score, private money always has served and will continue to meet, specific needs in the market.
During COVID-19 and the ensuing period of economic recovery, private lending will continue to further solidify its position in the capital markets as an irreplaceable, solutions-focused financing strategy.