Commercial mortgage rates are more misunderstood than my wife claims to be.
When I was in the residential business we all understood what risk based pricing consisted of, however when I crossed over to the commercial world it was as if I crossed into another dimension. Although certain lenders will publish rate sheets, in fact commercial rates are really driven by factors that come up from within the capital markets. The capital markets have been silent for some time however they are beginning to show their heads from the gopher holes. Commercial Lending Capital publishes rates to previously registered and approved brokers. Commercial Lending Capital treats rate sheets like a loaded gun; in the wrong hands they can kill a perfectly good deal. Let’s examine why in the following few paragraphs.
The Wall Street Journal reports that in the worst-case scenario, federal regulators examining the 19 largest U.S. banks are projecting losses of up to 12% on commercial real-estate loans over two years. Guess what happens when banks need more capital? They raise the price for the capital that they do have.
Regulators are likely to cite commercial-property debt problems as a major reason why at least some of the large banks need additional capital. Such losses likely would cause even deeper misery, and risk of failure, at small and medium banks because they tend to have disproportionally more exposure to commercial real-estate loans than giant institutions. Guess what happens when banks have a higher than expected default rate AND need more capital? They raise the rates (pricing) and they tighten the credit standards.
Analysts already had been forecasting hundreds of bank closures in the next five years. The stress-test assumptions, including a 10.3% jobless rate at the end of 2010, raise the specter that some of the failures could occur sooner. Guess what happens when banks expect to fail? They quit making loans and rate is once again immaterial.
The bottom line is that from this perspective banks need more capital, they expect the capital to cost more, and they expect a higher than hoped for failure rate among their peers. This allows the survivors to finally earn more money on their products that they sell, which translates into higher rates and shorter fixed rate terms. Given the above scenario it makes absolutely no sense when a loan producer comes forward indicating that their borrower wishes to lower their current interest rate. Over the next five years borrowers will not be in a negotiating position as the market readjusts. This is survival of the fittest and rate is just a product of risk.
Back to the first paragraph of this article whereby I indicated we only provide rate sheets to approved brokers. The purpose behind this strategy is that we are disseminating correct information to borrowers. Let me give you the two examples below:
Borrower One: Cash-out – $100,000 – 25% LTV – Apartments in CA. Cash-out is to conduct improvements that will increase rents and utility.
Borrower Two: Cash-out – $100,000 – 25% LTV – Apartments in CA. Cash out is to reimburse themselves for improvements already conducted one year prior.
Assuming the same credit profile, borrower two would likely not be approved in this marketplace or the terms of the loan would be much more costly. No lender is anxious to allow borrowers to remove equity from a property, as that tends to be a high risk, high default transaction. Now along comes our well intentioned loan broker with a rate sheet in hand that may not see the difference between these two transactions. The borrower would be quoted incorrectly and expectations would be set incorrectly.
A few years back there was a lot of discussion about which index was used to compute the final rate that the borrower will pay for a commercial transaction. Mortgage brokers and loan officers would telephone our offices (and those of our competitors) with open discussion and debate about what index they thought should be used. When the loan finally sold in the secondary market the index that the loan finally ended up was likely going to change. The index at the beginning of the transaction is like a façade at Disneyland Park; there is an entire netherworld behind the scenes. Today the business is much simpler. You either have the credit file and scenario required or you don’t and thus the rate is a byproduct of the transaction.
Our training system focuses on assembling the transaction and understanding the scenario before rates, expenses and fees are never determined or discussed with the potential broker or borrower. The originator that attempts to start the conversation by determining or discussing interest rates is going to lose every time. By example, if I informed you that your interest rate would be between 4% and 12%, you would hear one of two things come out of my mouth; either my rates are 4% and I am your biggest hero in the whole world or your rates are 12% and you are a crook. Either way you are likely to lose.
The moral to this story is this: money is tight, the capital markets are maximizing their return on investment, values are down in most areas, and dissemination of correct information to borrowers is at an all-time low. Commercial Lending Capital is helping to bridge this gap by innovative training programs and the limitation of sensitive information dissemination.
