Capital, or lack thereof, continues to be a challenge for commercial real estate developers and investors. But some organizations are finding creative ways to raise the necessary funds to build and buy. In this second of a four-part article series about real estate capital, Connect CRE talked to experts about types of flexible financing solutions available. Meanwhile, “Capital Markets: The Rearview Mirror and the Road Ahead” is available to read.
Here’s how real estate lending used to work.
A developer or investor would approach a traditional lender (think banks). The lender would analyze the applicant’s background, track record and other factors. The loan would be issued if all was to the lender’s liking. Then, the lender would repay the loan as mandated by the contract.
Here’s what we’re facing today.
Fewer traditional lenders in the real estate space. Pending debt maturities. Higher capital costs – and continued liquidity constraints.
The need for a higher level of creativity and innovation in the lending space. To provide more clarity on this topic, experts talked to Connect CRE about the growing flexibility of traditional lenders and different types of available liquidity.
The Traditional Side: Flexibility and Extension
One thing that came out of the Great Financial Crisis is that traditional lenders don’t want to own property. As a result, “I believe lenders and borrowers will try and work together to extend loans until they can be stabilized, refinanced or sold,” said PlainsCapital Bank’s Brian Heflin.
Jonathan Lee with Colliers Structured Finance Group said he’s already seeing this happening – and has been for a while. “We’re seeing borrowers engaged with lenders and working out extensions on their current debt,” he said, adding that the extensions are supported when borrowers are willing to replenish the interest reserve – and, in some cases, agree to pay down the loan.
Meanwhile, MetroGroup Realty Finance’s Ivan Kustic said that well-funded institutions have been able to offer “flexible, shorter-term financing terms to borrowers who feel as though interest rates are coming down.” He explained that several MetroGroup clients opted to place such interim financing on properties. “This helps them get through this next two to three years in anticipation of long-term rates coming down,” he said.
The Non-Traditional Options: Different Capital Sources
First, traditional lenders are under regulatory restraints. This means less flexibility in their practices. Second, more creative structures will come from private and non-bank lending sources.
“We’re already seeing stretch senior and “debtquity” in the market to help bridge cash-in financing requests on maturing loans,” he said. “Rescue and ‘white knight’ capital is also being raised in large amounts.”
Tower Capital’s Adam Finkel agreed, adding that more non-bank lending groups will come out of the woodwork to offer capital. Jon Pharris with CapRock Partners concurred, pointing out that private debt funds will likely be the most active lenders. But he sounded a caution, noting that “their cost of capital is high, which will continue to constrain asset values.”
Another potential source of liquidity? “Seller financing is still going to be a prevalent strategy, and that’s something that buyers have been trying to encourage,” Finkel said.
But seller financing and loan assumptions have their challenges, too. Sometimes, the leverage is too low, which might not be ideal for certain situations. As such, “it will be a strategy that some explore, but it likely won’t be a prevalent one because assuming a low-rate loan still results in low leverage,” Finkel said.
Along with private debt funds, Colliers’ Lee explained that bridge lending sources are stepping up to take many borrowers out of their current loans. And when bridge lenders can’t help, “many LP equity groups have shifted to preferred equity to bring in yield for their investors,” Lee said. “This has opened liquidity considerably.” This move can help borrowers preserve equity and ensure they don’t have to approach investors for more.
Jeff Salladin with Revere Capital also believed there would be more activity in the preferred equity and mezzanine debt space, but it depends on deal flow and asset values. “Until then,” he said, “the action is with senior, secured lenders.”
The General Consensus
None of the experts counted traditional lenders out in 2024, though they indicated they would be more selective in funding. They also agreed that alternative sources of financing would continue to offer different options.
Kustic, for one, summed up the situation as follows:
Life companies “have generous and ambitious allocations for 2024
The national banks will care for their institutional real estate clients but won’t “be a big force with local real estate development companies and investors
Regional and local banks will be under continued scrutiny by regulators and will remain selective in their underwriting
Debt funds and credit unions are an active source in the space
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