As the U.S. government strives to contain the turmoil in the financial market, the $1.5 trillion mortgage due in a couple of years poses a significant challenge for the real estate industry. There could be substantial downturns as real estate lenders anticipate a potential need for commercial loan refinance options. Unfortunately, this could mean higher interest rates and stringent credit standards for borrowers.
This article gives insights into how the recent credit trends affect lenders, borrowers, and the economy itself. It also suggests a way forward for borrowers in this season.
Stricter Lending Requirements
The recent turmoil in the financial market makes banks more conscious about loan requirements. Now, banks are issuing fewer loans and increasing borrower requirements.
A survey conducted by the Federal Reserve involving loan officers from 81 banks sheds more light on why banks have continued to tighten credit limits. The survey shows that banks were less likely to give loans to applicants with a FICO score of less than 680 for credit card loans. Most of these banks also increased the minimum payment amount customers can make when cutting down their outstanding balances.
The stricter lending conditions aren’t only due to the $1.5 trillion mortgage due soon but may also be traced back to the collapse of First Republic, Signature Bank, and Silicon Valley Bank.
Economic Impact of Stricter Lending Requirements
Tighter lending requirements could keep the economy in a tailspin as it limits the supply of goods and services by making borrowing unaffordable or unrealistic. When the supply of goods and services reduces, demand also reduces, causing inflation and other economic downturns. Below is a detailed breakdown of the economic implications of stricter lending:
Decreased Rate of Production and Investment
Lower demand caused by stricter lending requirements could make businesses scale back production to avoid excess products in the inventory. Depending on the nature of the company’s products, excess inventory build-up leads to damages, which in turn leads to a loss in the long run. Also, companies with a reduced rate of production don’t invest in more capital goods and equipment and are more careful about expanding operations.
Higher Unemployment Rate from Commercial Loan Refinance
When demand for products or services is less than it used to be, sales drop, resulting in layoffs or hiring freezes. The increase in unemployment affects the disposable income of families, which erodes purchasing power. Low employment rates reduce consumer spending and create a negative cycle of lowered demand and economic slowdown.
Apart from the direct impact of unemployment on families, high unemployment rates can also affect the mental state of employed individuals. It makes them more concerned about losing their jobs or more hesitant to search for other employment because they believe they are lucky to be “employed.”
Lower Revenue and Profits
Demand has a direct effect on business revenue. Low demand due to stringent lending requirements means less revenue for a business. Low demand for products and services also negatively impacts the company’s level of investment in research and development (R&D) for innovation, which in turn reduces profitability.
Problems with Government Revenues
Reduced demand can also be bad for the government as it leads to reduced tax revenues. According to a review by The Tax Policy Center, 9 percent of government revenues come from corporate income tax, while 30 percent comes from payroll taxes. Evidently, when there’s a reduction in company revenue and job loss, the government gets less revenue from corporate and payroll taxes.
Lower Valuations
Compounding the issue of stringent loan requirements, commercial real estate properties are getting greatly undervalued. A Market Insider Report says retail spaces could drop as low as 40 percent less than the initial price.
The drop in the value of commercial real estate properties could be traced back to the pandemic. There were lots of vacancies, and the decreasing rent impacted landlord financing, increasing the rate of loan defaults and reducing the value of the properties.
Based on a January report by IMF Blog, prices of commercial real estate have crumbled by 11 percent since the Federal Reserve began raising interest rates in March.
Economic Impact of Lower Commercial Real Estate Valuations
The impact of lowered commercial real estate valuation has both direct and indirect impacts on the economy.
Borrowing and Lending
Most businesses use real estate as collateral for most loans. So, when the value of a property reduces, the value of the collateral backing those loans declines.
The impact of the drop in valuation will affect how borrowers can access credit or commercial loan refinance. Lenders may become more cautious about extending credit against low-value properties.
Less Construction and Development Projects
The reduced value of existing commercial real estate can discourage businesses from developing new ones. Builders, developers, and engineers may choose to delay or cancel construction projects to avoid losses due to a diminishing value. Unfortunately, the reduction in construction activity creates a ripple effect on related industries, leading to job loss and increased unemployment rates.
Market Volatility and Investor Sentiment
Real estate is known to be significantly stable and serves as a major asset class for institutional investors and real estate investment trusts (REIT). So, when property values seem to be falling drastically, there’s a high chance that investors will begin to lose confidence in real estate. When the lack of trust in the real estate market lets investors pull out their investments, there could be broader implications for the financial market.
Reduced Net-Worths
Real estate, both commercial and residential, is a major source of wealth for most individuals and families. So, a reduced property value leads to lower net worth for those individuals. Ultimately, when these individuals become conscious of the reduction of their net worth, they become more conservative about investments. This conservative behavior could impact the financial market and the economy.
Will the U.S. Commercial Real Estate Meltdown Cause a Banking Crisis?
According to the NBER report, 14 percent of all commercial real estate loans and 44 percent of office building loans have a negative equity position. This means their debt is greater than the original value of the property. So, there’s a high chance that borrowers won’t repay loans. This might affect the commercial loan refinance.
Banks like the New York Community Bancorp are feeling the commercial property pressure. In February 2024, they plunged over -37% and raised their provision for loan losses to $552 million, mainly due to exposure to commercial property loans.
Hard Money Becoming More Significant for Borrowers
Due to all of the financial meltdowns, lenders are beginning to change or include more loan restrictions. So, if you don’t want to work with your existing lender and you dread the loan restructuring process, you should consider hard money as a bridge loan. This option could prove more effective than refinancing through a conventional bank.
Hard money will allow you to buy time to wait for rates to reduce or sell your commercial real estate. Unlike other bank credit options, hard money is an interest-only option. So, payments are typically less than an amortized loan, helping you bridge the gap.
Most decisions from hard money lenders are based on your equity and not credit scores, occupancy, debt service coverage ratio, or income. Hard money loans also have an easier and quicker approval process in comparison to bank loan structures.
Below are other reasons why you should consider a hard money loan to ease commercial loan refinance:
Non-Traditional Collateral Acceptance
Unlike bank loans, most hard money lenders are willing to accept non-traditional forms of collateral like high-value cars of art. So, if you possess valuable assets but are confined by the strict requirements of traditional banks, hard money loans are a great alternative.
Less Stringent Documentation and Loan Conditions
Hard money loans have simple documentation requirements, which could help streamline the loan application process and appeal to borrowers seeking less stringent processes. You also have fewer restrictions regarding how you utilize your loan, with little to no micromanaging. Inevitably, this gives you more autonomy and flexibility in deploying funds for various business purposes like expansion or increasing campaign budgets.
Short-Term Financing
Hard money financing should be a major consideration if you’re looking to close within a week. Apart from the speed in closing these loans, you can choose a short repayment period as well. This system is excellent for businesses looking for project-based funding.
Get Ahead of the Wave with Capital Max
Capital Max is an alternative fund placement and creative financing firm that supports hard money lending. We help get you a loan based on equity even when your bank declines your extension. Whether you need a fast close or less documentation for loan approval, we are your best shot in this time of financial crisis. Reach out to us if you have any questions or need clarification.