Shareholder Robert Stern Authors Article on The Future of Construction Loans in a Post-Pandemic World for Construction Executive
Like most businesses, commercial real estate developers and lenders were significantly affected by the worldwide COVID-19 impact in 2020, which had a direct impact on the ability for construction projects to move forward. As we all look ahead to moving past the pandemic and as roadblocks that slowed down projects are removed in the coming months, we can expect banks and developers to be eager to start building again, although certain types of projects may be more attractive than others due to the pandemic.
LAST YEAR’S OBSTACLES FOR FINANCING
The COVID-19 pandemic introduced a myriad of challenges for lenders, including a massive and unanticipated rise in loan defaults, restrictions due to eviction and foreclosure moratoriums, and new loans to make through the Paycheck Protection Program (PPP) and CARES Act.
The Small Business Administration introduced the PPP loan program to assist and incentivize small businesses to retain employees during the economic crisis with forgivable loans for those that meet retention criteria and use funds for approved expenses, including rent and mortgage payments. Along with other financial assistance programs, PPP loans helped to alleviate the need for default and collection actions against many businesses. Lenders have therefore been able to offer some level of leniency for borrowers that are behind on payments, which is especially the case for landlords with delinquent tenants.
In addition to the financial impact lenders felt due to borrowers who were unable to make payments, they were confronted with the complexities of the new PPP loan program with a very short amount of time to understand it before underwriting, approving and closing a large amount of these loans. Thankfully, financial institutions exceeded all expectations by funding more than $525 billion in new PPP loans over a short period of time, while also continuing to serve existing customers.
However, rising to the occasion to meet the demands of funding PPP loans, most lenders were unable to meet their typical level of service for current customers or seek out new construction loans to help reach the lending goals established before the pandemic. While that was bad news for construction projects in 2020, it likely means lenders will be eager to finance new loans in 2021 and have a large backlog of funds to do so.
CONSTRUCTION LENDING EXPECTATIONS IN 2021
Banks will be busy with recovering from bad loans during the first quarter of 2021 as we anticipate a wave of defaults and bankruptcies due to the continuing pandemic, and while they go through the process of collection, eviction and enforcement actions, they will want to get more good loans on their books.
The most attractive and easiest projects to finance will be those that can best demonstrate that they will, in fact, be the good loans lenders are seeking. This includes projects with the strongest deal sponsors who have a high liquid net worth and make unconditional personal guarantees of the loans. Sponsors can demonstrate personal investment by putting more of their own finances into a project to lower the ratio of the loan amount to the project value.
With economic recovery on the minds of lenders looking for stability, they will also be attracted to markets with promising economic factors. For example, Florida has strong population and job growth, a balanced budget and no state income tax, and Florida will likely continue to draw new banks, deals and developers as a result.
Of course, projects for different industries will vary in their ability to attract financing due to prospects for their businesses to perform in a post-pandemic world. Industrial warehouses and last-mile delivery companies offer the strongest rents and most demand, which also make those developments the easiest to finance. New medical facilities and offices will also continue to be attractive for lenders. On the less positive end of the spectrum, hospitality projects will be the most difficult to fund as the travel industry continues to suffer. The outlook for restaurants and retail development will be dependent on economic reopening and a return to full employment
While there are many factors at play as to when we will see a resurgence of financing for projects in different industries and locations, we expect an increased demand for construction loans in 2021 and that banks will be interested in funding those loans as they look to return to normalcy.