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How to Survive a Brave New Mortgage Market

Even as property sales charge forward, buyers today face many challenges when closing a deal. Whether you’re seeking something in the commercial or residential fields, here’s what you need to know in this new marketplace.

Just halfway into 2015, the year is already a good one for those in the real estate industry. Last summer, real estate agents said they were enjoying the best year in recent memory, and this year is even better.

At Home State Bank, in Crystal Lake, business is nearly 50 percent better than last year, says Greg Grojean, senior vice president of the home mortgage division.

This May, closed home sales in McHenry County were about 15 percent higher than in May 2014. As inventory has dwindled, sale prices have climbed nearly 5 percent, according to data compiled by Heartland Realtor Organization (HRO), an association of real estate agents in the county.

Although the region’s real estate market appears to be charging forward, it’s still in a recovery mode.

For one thing, home equity isn’t yet in line with home prices. Many potential move-up buyers are choosing instead to stay put, says Jim Haisler, CEO of HRO. They fear taking a loss on the sale of their homes.

“McHenry County was growing very quickly before the recession, and we were one of the fastest-growing counties in the country,” says Haisler. “When that real estate bubble popped, a lot of people felt the price crunch. Their homes were no longer worth what they paid for them, so now they’re wondering, ‘How can we move?’”

Homes priced below $250,000 are moving fastest, says Haisler. The market for higher-end homes, above $500,000, is recovering at a slower pace.

The story is the same for commercial properties. Smaller ones, generally less than 10,000 square-feet, are moving faster than larger properties.

“Just like housing inventory, we could use a little more commercial inventory,” says Wayne Kurchina, CCIM, HRO’s president-elect and a managing broker for ILrealty Inc. “Because we haven’t seen a large influx of new or expanding businesses, buildings in the 50,000-square-foot-plus range aren’t moving as quickly.”

In both commercial and residential real estate, opportunities for the buyer abound. Mortgage rates remain relatively low and undervalued properties hold potential for financial gain. Whether you’re looking to settle into a new home or expand your business into new territory, it’s important to be aware of the market’s new standards and conditions.

Mortgages for Business Properties

Obtaining a commercial mortgage is, in many ways, like obtaining a home mortgage. Ample documentation is required, along with an appraisal and property inspection – but in other ways, the process and requirements are very different.

Home mortgages are sold on a secondary market to groups like Fannie Mae and Freddie Mac, but commercial mortgages are retained and serviced by your bank. Banks often adjust the interest rate in five-year increments during a 20- or 25-year repayment period.

“Competition in this area is very strong, and most everybody’s rates are competitive, depending on the amount of risk we’re facing,” says Keith Leathers, senior vice president of Home State Bank’s commercial lending division. “The better the risk you are, the better your loan rate.”

Low interest rates and decreased land values have tipped the market in favor of buyers, rather than builders.

“The cost to build something is what it costs,” says Leathers. “Construction costs X amount of dollars. Wood costs X amount of dollars. Just because the economy isn’t doing well doesn’t mean the cost of goods has gone down.”

Rick Zonts, senior vice president and market manager at Elgin State Bank, likes to help his commercial clients be prepared before seeking a commercial mortgage. He expects a business to be tracking things like cash flow, financial statements and tax returns, both for the business and its major principals.

Those who own more than 20 percent should be prepared to be a guarantor of the transaction, and will need supporting documentation.

Zonts also prefers to see solid research on a new property. If it’s an investment property, are the tenants locked into long-term leases? If a tenant were to leave abruptly, how would the owner absorb the loss of rental income?

“The bank will do a deeper level of due diligence, and we hope that the client is doing it upfront,” says Zonts. “We may come to you and say, ‘These are the pitfalls, and you should consider these in review of the property.’”

Equally important, if the new property will be owner-occupied, Zonts wants to know the company’s growth strategy for the next 10 years.

“You need to consider, ‘Where’s my business right now, and how much square footage do I operate in?’” he says.

“Then, ‘What are my growth plans?’ You don’t want to consider these items frequently, because moving expenses can be arduous.”

Property taxes may also factor in. Measured by the square foot, commercial real estate taxes tend to be higher in Cook County but lower in DuPage, Kane and McHenry counties.

“For office space, you might pay $2.50 or $3 per square foot annually,” says Zonts. “So, if you own a 2,000 square-foot office in Elgin, it might cost you $6,000 a year in real estate taxes. In Cook County, I’ve seen taxes as high as $8.50 per square foot.”

As always, location factors in heavily when identifying the best real estate opportunities. McHenry County’s market is improving fastest in the larger population centers, says Leathers.

“I think as you get toward Chicago, things seem to be picking up,” he says. “There are lots of pockets of growth, and lots of pockets of non-growth.”

Lingering effects of the recession have created a strong opportunity for investors in multifamily dwellings. “Not everyone can meet the requirements of a residential mortgage loan,” says Leathers. “People have the money to live in nicer apartment buildings, even though they don’t have the down payments to get into a house. So, we see a lot of apartment buildings going strong.”

Zonts notices the same thing in Kane County, where multifamily and retail developments have rebounded.

“You’re starting to see homebuyers take that step out of the apartment. More of that is on its way, once there’s more inventory,” he says. “For now, the economy is keeping occupancy rates in multifamily very flush. It’s a good position to be in, if you own those buildings, but we’re seeing rates start to rise on those properties. The question, now, is when are we going to go beyond a tipping point?”

Just as a home is inspected and appraised before it’s purchased, commercial property also must be evaluated carefully.

“Do your research on deferred maintenance,” says Zonts. “It’s important to have somebody come in and look at the roof, look at the air conditioner. People forget to do that.”

Appraising a commercial property costs between $1,700 and $5,000, says Leathers, and provide essential information. Most appraisals contain three values: an assessment of nearby and like properties sold within the past six to 12 months, the potential rental income of the property and the value of reconstructing the property.

An experienced banker can help a business owner to identify overvalued properties.

“We’ve got enough experience putting these together that we can say that it looks like it could be a pretty good ballpark price,” says Leathers. “Or, we might be able to say that we think it’s a little high, and there’s a decision to make about the property.”

Kurchina, of McHenry’s HRO, advises his commercial clients to look closely at industry definitions, so that they understand exactly what they’re agreeing to. Terms such as “Gross vs. Net,” “Triple Net,” “Vanilla Box,” “Standard Buildout,” and “Insulated Shell” often vary from market to market, says Kurchina.

“A retail space with open-grid ceiling, exposed rafters and duct work could be considered a vanilla box to some, while others would say, ‘No, it doesn’t have acoustical drop-down ceilings,’” he says. “Using an industry professional helps to clarify what is being agreed to, and keeps both sides of a deal in harmony.”

Many clients, especially those in manufacturing, look closely at proximity to transportation routes. Haisler, of HRO, knows of several companies that have based relocation and expansion decisions on proximity to major thoroughfares, which are harder to find in some parts of the county.

“If we don’t have major roads nearby, how do we get products to Rockford’s airport to move it out?” he says. “How do we get products to O’Hare? When companies are looking to move here, they’re looking at what access we have.”

Buying a Home

The recent recession and its real estate bubble brought about tighter lending requirements and increased banking regulations. In many ways, the recession simply returned traditional home mortgage products and standards to the way they once were.

“The biggest change in the market in the past 10 years has been a shift back to affordability and being able to show that you can qualify for, and afford, the mortgage that you want,” says Grojean, of Home State Bank. “The days of stated income loans are long gone, and now it’s about showing that you can afford the loan you want and that you have a history of making payments.”

The best starting point in today’s market is the prequalification process, which should happen before involving a real estate agent. During this process, a lender will evaluate the homebuyer’s finances and verify how much home they can afford. Once a homebuyer’s offer is accepted, this prequalification information will be used in the formal mortgage application.

Lee Pederson is senior residential lender with Wintrust Mortgage and its cousin, Elgin State Bank. When he meets with potential homebuyers, he wants to know they’ve done their homework. Homebuyers who are organized and prepared generally have an advantage.

“One of the important things you should determine before calling a lender is a household budget,” says Pederson. “A good lending officer will ask you, ‘What is the maximum purchase price you feel you can afford, and what is the maximum monthly payment you’re comfortable paying?’”

It’s also a good idea to set aside funds for a down payment well in advance. Setting them aside in a checking or savings account makes them easy to track during the underwriting process, says Pederson.

Lenders also scrutinize credit scores, which should be checked well in advance, so that any potential issues can be resolved before a mortgage application process starts. Sherry Blondell, loan officer with American Midwest Bank, which has locations in DeKalb and Kane counties, says the lowest acceptable credit score is around 620 to 640.

“Credit score is everything,” she says. “It can change your interest rates by half a percent. People need to keep their credit clean, and they need to have a score. We encourage clients to use their credit card and pay it off, so there’s a stream of credit.”

Documentation is essential during the qualification process, and it’s more demanding than ever. Expect to submit a month’s worth of pay stubs, two years of W2s and tax returns, two months of asset account statements, and a driver’s license or state ID. Be ready to track any large deposits, too. Blondell says it’s not uncommon for clients to save too little for a down payment.

“Underwriting will look for large cash deposits in your bank account, so if you loaned your brother $5,000 and he paid you back, that’s a tough one to verify,” she says. “If you’re getting ready to make big purchases or deposits, they’ve got to be well documented, with a paper trail.”

For those who haven’t purchased a home in the past decade or so, the prequalification process may seem unusually burdensome. That’s partly because of the regulatory environment, says Pederson, but it also helps to make underwriting go much easier.

“You might be saying, ‘He’s asking for a lot of stuff that I didn’t need six years ago.’ But, just work with me,” he says. “Give me everything we need, because if we have everything on the front end, everything is going to go smoothly throughout.”

A reputable banker can navigate a homebuyer through the qualification and application process. Because it’s a relationship that develops between banker and client, Pederson advises shopping for the right lender, by seeking referrals from friends, family and trusted real estate agents.

“Your first question should not be, ‘What are your rates?’ and yet 95 percent of the time, that’s the first question,” says Pederson. Rather, it’s important to find somebody who’s accountable, knowledgeable and service-minded.

When Pederson makes a loan, he doesn’t just bring the firepower of Elgin State Bank, a subsidiary of locally owned St. Charles Bank & Trust. He also brings the firepower of Wintrust Mortgage, part of the bank’s parent company, which is based in Rosemont and serves locally owned banks throughout greater Chicagoland.

Home State Bank, which celebrates its 100th anniversary this year, is similarly community-focused, with all decisions being made by lenders based in McHenry County.

“For us, it’s not about selling the next mortgage and the next customer,” says Howard Ackerman, CMB, a senior vice president at Home State Bank. “It’s about sustainable homeownership. How can we make homeownership a successful experience for you?”

The bank coaches its customers during homebuyer education seminars at its Vernon Hills branch. The seminars walk people through the buying process, from prequalification to closing.

“If you look at the neighborhoods that are successful, it’s where the homeowners are able to take care of their homes and maintain them,” says Ackerman. “If you look at communities and neighborhoods where values have gone down, it’s where homeownership has failed. We want to work with each customer and help them to become successful homeowners.”

It’s been a busy season for lenders in northwest Chicagoland. Pederson says most of the growth he’s seen is among first-time buyers. Move-up buyers have been reluctant to enter the market for homes priced above $417,000 – the starting point for a “jumbo mortgage.” However, Pederson sees several incentives for buyers interested in a larger home.

“Jumbos have always been more expensive than a conventional loan,” says Pederson. “That’s actually changed. They’ve now achieved parity, where your jumbo mortgages carry roughly the same interest rate as conventional loans.”

Because they involve higher-cost homes, jumbo mortgages require a greater commitment from homebuyers. Any down payment below 20 percent is problematic, as are credit scores under 700, says Pederson.

Blondell finds that everything is scrutinized more closely when underwriting a jumbo mortgage. Gone are the days of stated income and stated asset mortgages.

“They’re going to look a lot closer at the tax returns if the buyer is self-employed,” says Blondell. “The credit score has to be in the 700s, and the debt-to-income ratio in some cases can’t exceed 41 percent.”

Traditional, 30-year mortgages are in vogue, but qualified customers might find additional deals on shorter terms, such as 15-year or 10-year fixed loans, says Blondell.

“On a $200,000 loan amount, with principal and loan at 4.25 percent on a 30-year fixed, you’d pay $983.88 per month,” she says. “A 15-year is 3.25 percent with a $1,405.34 per month payment. There’s a huge increase in the monthly payment amount, but if you look through the truth-in-lending statement and see what the savings are on interest, it’s huge.”

Take a Leap

Interest rates remain at near-historic lows, but Kurchina and Haisler, of the HRO, suspect that several market forces are suppressing demand. There’s talk that the Federal Reserve intends to raise rates soon, but there’s no guarantee when.

“I think what will push the market is when those rates start to go up,” says Haisler. “That’s my guess, because rates have been bouncing around. When they start to steadily rise, that’s when people will jump off the fence.”

Kurchina believes that slow business growth is influencing the higher-end housing market. “We haven’t seen a lot of corporate expansion or new manufacturing businesses coming to our area,” he says. “This type of activity would help to generate more interest in the higher-end residential market.”

The supply of homes still lags behind demand, but conditions look far better than they did even one year ago. Pederson, of Wintrust Mortgage, sees opportunities for players in many parts of the market.

“We’re seeing a lot of multiple offers, bidding wars, people paying more than list price because there’s not enough inventory out there,” he says. “Now, what has to happen is that the move-up buyer, the person who owns a home, needs to put it on the market so that the first-time buyer can take it. Then, the move-up buyer goes to the next, more expensive property. It’s starting to happen, but that’s our next phase.”