Some of you may know the movie reference here, “Dude, Where’s My Car?” The story follows Ashton Kutcher and Seann William Scott (aka Stifler) as they awaken hungover with no memory of the previous night, and most importantly, where they parked their car. The movie predates The Hangover, but it’s essentially the same premise.

So what does this have to do with commercial real estate lending? Well, for starters, over the past 6 months I think we’re all waking up every morning disoriented and trying to find out what the heck is going on. But, more importantly, investors are trying to navigate an ever-changing lending landscape that ultimately impacts their investments.

Typically, when an investor buys a commercial property that appreciates in value over time, the borrower can tap into that newfound value through a cash-out refinance or sale. While not a highly liquid asset, real estate’s ability to eventually return cash to the investor is critical.

Well, over the past 6 months, with COVID running rampant across the globe and wreaking economic havoc, lenders have become much more conservative with both their underwriting and their loan structuring. We’ve written about lenders lowering LTV, increasing cash reserve requirements, artificially inflating expenses, etc. The list can go on, but there’s one thing that borrowers want and lenders seem to be holding back, and it’s the ability to pull cash out of a property.

Why cash out spooks a lender

A large majority of lenders are not providing any sort of cash out refinances in the current environment. Lenders aren’t confident in the direction of property values given the devastating toll COVID has had on the economy and so when investors are refinancing properties, lenders prefer to keep equity in a property to provide a cushion against potential future decreases in property valuations. Let’s look at an example:

Below we see a property that is worth $5,000,000 and has a loan of $3,000,000 (60% LTV). With 40% equity, there’s a significant amount of untapped value that investors may want to pull out via a cash-out refinance. So, if the investor does a 75% LTV cash out refinance, they should be able to pull out $750,000 of equity.

Now, what happens if the property value decreases by 30% to $3,500,000 (this may be a stretch, but I’m exaggerating on purpose). Those lenders that did not allow investors to pull cash out still have an equity buffer, however, those that did will not fare as well and could be under water. See below.

How to find liquidity

Staying conservative is all well and great for lenders, but what about the investor?

Borrowers want cash and they want it now.

Why?

Well, for starters, they’ve earned it. They may want to increase their own cash reserves, acquire additional investment properties, pay down personal debt, invest in other businesses opportunities or even the stock market. The list can also go on and on, but at the end of the day, they want their equity, and who’s to tell them they can’t have it? We see this battle play out everyday and we engage with hundreds of investors and lenders across the country.

So, with investors and lenders in a tug-of-war over capital, how does this play out?

Investors can find a lender out there allowing for the right amount of cash out on their deal, but they increasingly need to step out of their local lender relationships to do so. A wider approach to canvassing for the right lender has become much more common.