Private Real Estate Credit
Investors Are Taking Notice
By Brian Walter and John Lettera
Commercial real estate focused on one to four and multi-family is in the initial stages of a seismic shift in its financing. The recent ills of regional banks, along with the threat of impending legislation and the need for greater balance sheet liquidity, means that capital that used to flow freely is drying up—with no sign of easing.
The financing path to creating a stabilized asset is changing rapidly, and private real estate credit will play a crucial role in providing capital for commercial residential acquisition and development, as well as for other real estate sectors.
Regional banks are paused on lending
Regional banks make up over 50% of real estate lending in the U.S. As seen with large regional players like Silicon Valley Bank and First Republic Bank, regional banks are now squeezed on liquidity, fear a run on their deposit base, and are overweight in real estate loans. To create a more liquid balance sheet, they could sell assets which could produce realized losses, which is not an ideal choice.
Their next best option is to pause or slow lending. Banks are even declining real estate loans for those with whom they have long-term relationships.
Private real estate credit is actively lending, and new borrowers are noticing
A new wave of borrowers sees what many builders were already attuned to: that private real estate credit comes with higher rates. But there are significant offsetting advantages that make it a highly attractive source of funding—and private credit has funds to lend.
Just as corporations once balked at private alternatives to JP Morgan, Citigroup, and other institutional lenders circa 2010, those corporate borrowers found that the delta between bank rates and private rates was not that material once you factored in private lending’s faster execution and ease. And private corporate lenders found that their new borrowers were also better quality, having been pre-vetted by the institutional banks.
Parallels between the rise of private corporate credit and private real estate credit
The exodus from corporate to private credit post Dodd-Frank changed the corporate financing landscape. As demand for private credit grew, and investors saw the burgeoning opportunity for returns, loan sizes were able to increase. Today, there are private corporate lenders who, on their own, can issue a $1+Billion loan, placing them in the same rarified league as institutional banks.
Corporate borrowers gained appreciation for the fact that private corporate credit is not hamstrung by bureaucratic red tape. With flatter organizations and less regulation, private lenders can be more creative in their loans.
Furthermore, whereas institutional banks would syndicate their loans causing borrowers to work with hundreds of smaller holders when they wanted to make loan changes or amendments, corporate borrowers now basked in the relief of working with just one or a few private lenders.
Private real estate credit offers the advantages of private corporate credit: speed of execution, creative financing solutions, and a lender who will work with borrowers when challenges arise. The seeds are planted for this market to experience the same growth as private corporate credit.
Real Estate Bridge Lending
Bridge lending serves a valuable role in providing private short-term capital to real estate developers. Bridge loans can be anywhere from 3-24 months and fill the financial gap between property construction or rehab and when a property can start generating income. Once a property starts to generate cash flow, the developer can switch to a bank or agency loan, or exit.
Bridge loans have not received as much attention as bank loans, but that is changing. For many builders, bridge loans have become a staple of financing development for three very compelling reasons: less paperwork, faster execution, and greater flexibility. Developers who never explored private credit are taking a closer look.
A private market bridge loan can close in less than a month compared to the three or four months to close on a bank loan. With a private market construction draw, a developer can gain access to money in as little as five days versus three or four weeks through a bank. Speed is important to securing opportunities.
Developers counter the private market’s higher rates with the costs that can be incurred by not moving quickly. With construction draws occurring faster with a private loan, a developer can build quickly and keep subcontractors happy. Waiting for bank construction draws can make a project take 1-2 months longer to finish and create tension with subcontractors. While bank financing is cheaper, the developer may have the loan outstanding for more months because of slow bank draws.
Plumbers, electricians, and other skilled subcontractors are in high demand and short supply, so paying subs promptly is essential to keeping them on the job. If a builder waits for a loan draw or even for a loan to close, the money to pay subcontractors must come from the builder’s own pocket. The construction draw process from a private bridge lender can ease the pressure on a developer’s working capital.
Investors are taking notice
This seismic shift is also gathering attention from investors. The potential for non-correlated higher returns (through higher loan rates) is complemented by a hard asset as collateral to protect principal. Depending on a bridge lender’s approach for repeat borrowers, leverage, geographic diversification, and due diligence, risk can be mitigated even further. In the case of non-performance, private lenders stand before all others in getting recompense.
Investors who participated in corporate credit now pat themselves on the back for consistent returns. With quality builders looking for funding, investors interested in private real estate credit are at the same watershed moment that corporate credit was 13 years ago. With demand for loans far outpacing available capital, managers can be more discerning and structure better loans.
Shifts in financing create opportunities
Change causes us to look at the world with fresh eyes. Where large corporate banks once controlled corporate credit, private corporate credit has become a force. Where regional banks once dominated real estate lending, real estate private credit is taking off. And those who join the movement early stand to benefit.
