An Insiders Tale: Why Banks are Tightening on Real Estate Investments

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I just got off the phone with the commercial lending VP at a small local bank.  This bank just survived its first Office of Thrift Supervision audit since the financial meltdown.  This audit took the better part of two months — all for a bank with less then $200 million in assets.

As I mentioned, they survived.  That means that the auditors accepted their loan products, their underwriting processes, loss mitigation methodologies, and their loan delinquency rates.  All-in-all… not a bad day at the office.

Except that the auditors were very concerned that this lender is one of a few in their market that is still catering to real estate investors and as such, were exposing themselves to ever increasing risk as fewer and fewer lenders were available.  Coupled with this is the pessimistic economic outlook promoted by the auditors over the next 3 – 5 years.  It ain’t pretty, and the regulators are requiring lenders to protect themselves now just in case things don’t improve – which based on my conversation, isn’t likely to happen too soon.

Here is the situation this lender and almost any lender is confronted with. 
All lenders can only have a certain dollar value, as measured against its total asset base, of loans in any single asset class.  Real estate is an asset class.  Normally this is not a big deal, as many loans are retired either through the sale of the property or because many small lenders can bundle their loans and resell them to larger banks, thereby recapitalizing their loan coffers.  The challenges are two fold: first the level of certainty that a property will sell is quickly diminishing with the expiration of the Homebuyers Tax Credit and secondly, no one wants to buy real estate loans. 

This forces small lenders to have to keep the loans on their books and in time, as they continue to underwrite more loans, they soon reach the limits for the real estate asset class.  There are just a few things a lender can do at this point — sell stock or increase profits.  In today’s economy, you can readily see the challenge in this scenario.

So… what to do?

Here is what this lender is planning to do

They are going to continue with their purchase and renovation loan product.  They are going to be extremely selective about who they make these loans to, in terms of experience and overall knowledge.  Their criteria are going to be more stringent, with special attention being paid to available reserves and the quality of the deal.  They are going to reduce their LTV to further protect their position.

In essence, they are doing exactly what every investor in today’s market should be doing, buying low to lock in their profits while mitigating future downside risk.

They are less optimistic regarding longer term loans.  Loans that would normally be made for rental properties.  Their reasoning is simple. What if the property values continue to fall and end up below the loan level, and what if the borrower can’t get the loan refinanced at the maturity date?

And with that in mind… here is the other point that was made that only helped to confirm our topsy-turvy world.  For many banks having difficulties today, who have a large number of real estate loans, good or bad on the books coming due within 12 months of their maturity date, the banks are being told to have the borrowers get a new loan or the bank will be forced to place the loan into default and foreclose on the property.  And, since borrowers are having the dickens of a time finding new financing, they are being forclosed on.  Did you get that? Even if the loan is performing the banks are being told that they can’t issue a new loan — they have to foreclose

This is absolutely nuts, and only serves to reinforce the idiocy of what is going on within our Government.  

Now, what do we to protect ourselves, our portfolios and our businesses?

I don’t think the answer lies with better relationships, or more knowledge, or greater amounts of capital.  No, I think the answer to this situation is that we are going to have to ensure our elected representatives understand just how important real estate investors are to this struggling recovery.  They have to be shown that through policy or regulatory decisions, often times arbitrary at best, they are strangling the only sector of the real estate market that is thriving… real estate investments!

How do we do this? I’m not sure, but I am open to your suggestions.

About Author

Peter is an active and successful real estate investor in the Baltimore Maryland region for the past 8 years and is one of the founders of The Club Mastermind a real estate investing coaching program focused on local coaches helping investors to perfect their game.

18 Comments

  1. Peter, I concur on the importance of investor participation in the recovery. I do feel the 1 year reprieve on the FHA seasoning requirements was geared in the investors’ favor. Do you know of anything else the government or legislation which is pro-investor?

    I’m getting mixed responses from my banker friends. A lot which haven’t hit their limitations are just renewing the commercial and loans if the borrower is paying. Others which have hit their limitations are worried about having to call the loans due.

  2. Ryan,

    I don’t know of any specific legislation at this time. There are several things that do concern which I will be writting about in the coming weeks. One of the biggest is that the Fed is supposed to buying mortgage backed securities. The fear is that if the Fed stops buying the secondary market which was the FED will totally dry up and the entire system will freeze.

    Interesting times… indeed!

  3. Out of all the government intervention expiring of the Fed buying MBS is the greatest cause for concern for investors. It will be a rude awakening for many people who are sandwich-to-sandwich right now.

    I look forward to the writings you have coming soon!

  4. Peter — Stellar summary of what happens when the ‘back-line’ folks are in charge.

    It is absolutely nuts, especially when we consider the loans they’re promoting for owner occupant buyers. 3-10% down. 580 FICO, etc. But an experienced investor with 20-30% down, massive reserves, and a 720+ score? Nyet. When prudent investors are willing to put that much skin in game, with more than adequate cash reserves, and are denied DUE to their experience, it makes one think rational thought is rare indeed.
    .-= BawldGuy Talking´s last blog ..Convert Your IRA To A Roth – Spread The Tax Impact =-.

  5. I am a lender and the argument I have always heard from banks is that if an investor has a portfolio of several properties, and owns their primary residence, and they get into financial difficulty, what home are they likely to let go first? Definitely not their primary residence.

    Also, I agree with the above comment- the end of the MBS purchase program and looming inflation are almost certain to cause an increase in rates which will be a rude awakening for many people who have become spoiled by 5% 30 year fixed rates.

    • Your first comment is right on the money. I didn’t mention that point in my post… but the regulators want lenders to look at “global” cash flow. Meaning how many properties are owned and what is the possibility that if one property heads south… it will pull all of them down.

      And yes… we are in for a rude awakening in the next 6 – 9 months.

  6. This is an excellent post. I have heard from two bankers that even though the administration is encouraging an expansion of current lending levels regulators are putting the hammer down. The Treasury Departments program of purchasing both treasuries and MBS is winding down. It has helped to keep mortgage rates artificially low, and the day of reckoning and noticeably higher rates not too far in the future could be painful.

    • Ted… we are in for some interesting times and the lenders aren’t sure what to do… whenever there is confusion in the market… it will freeze. Hey, I’m not a genius, but if could figure that out you would think some brainiac in the government would.

  7. Your article reinforces why private and hard money lenders such as myself are in such demand. For the reasons you wrote about, the market has forced us into a niche in hard money lending, we only finance real estate investors to purchase and rehab houses in and around Detroit and sell these Notes to private investors, many using their self-directed IRA’s. Unlike hard money of the past we now expect higher credit scores, provable income and the exit strategy must be in place to refinance or sell. Our LTV is only 50% based on after-repair-value and our terms are only 13 months, but unlike your bank we can extend the term and not foreclose. Many investors ask why would anyone pay the higher rate and fees if they qualify for conventional financing? My response has been simply, no one else will lend to investors in these cases regardless of the quality of the borrower or how much the deal makes sense. As always, when institutions cripple the market with unwavering and shortsighted actions the private sector will have to step up to take their place.

    Hard Money isn’t cheap, but cheap money is no good if you can’t get it.

  8. This is the best we can do? I am continually amazed at the amount of dumb decisions that come out of the government-who just happens to have all the resources. Foreclosure on performing loans rather than extend? Stupid

  9. Excellent Post John,
    Having spent part of my career as VP during the S&L crises, the one thing that stands out in comparison with today’s market is what I call the “Who Done It Factor”. Blame game legislation to protect the consumer from all of us bad guy Investor/speculators. Little by little Green shuts are appearing, however, because the Feds know that although we were part of the melt down problem we are also the only ones that have the capacity to bring back and save the market. It will truly be interesting to see what happens when the Federal Reserve stops buying up all the secondary market mortgages in March. Thanks again for a great post John.
    .-= matt mathews´s last blog ..California posts nation’s largest foreclosure total in 2009 – Los Angeles Business from bizjournals: =-.

  10. Very appropriate comment by Matt. The Fed has definately been holding rates down. It could get even more interesting if China finds an economy starting to grow that it likes better or decides for any reason that they no longer wish to be the largest holder of our treasuries. Regardless of how strong we have been, the national debt is a LARGE pill to swallow.

  11. Eric in Silicon Valley on

    The other day I got a flyer in the mail for what was called an SBA (Small Business Administration) Express Loan. I don’t know the details, but they suggested that small businesses might get a credit line up to $50k, unsecured, with minimal paperwork. I looked this up online, and it seems that all the big banks are promoting this.

    We know the current administration is trying to push the love down to small businesses after the big business have been supported. I’m trying to make sense of the big picture but am having trouble. Are small businesses in general being encouraged, while real estate in particular is a lending red flag?

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