Reliable borrowers find good deals, even when banks are skittish. Article by: Steve Belleville, director of sales and marketing, Redwood Mortgage
No matter how creditworthy, small-capital mortgage customers tend to feel the squeeze between tighter bank-lending standards and the significant financing expenses of many private lenders. There is a middle ground for qualified small-cap borrowers, and originators can profit by guiding their clients to it.
Commercial real estate lending is clearly not a one-size-fits-all business, and one slice is decidedly underserved as a result of recent and continuing market trends: the middle-market bridge loan.
Banks and institutions are lending as they always have to large core clients in real estate, but they are challenged in meeting the midsize-to-small real estate investor’s growing demands. Meanwhile, at the other end of the spectrum, the private-loan industry has a strong track record of helping investors with special needs outside traditional-lending parameters, but their products are often short-term loans at double-digit interest rates.
Market forces, as a result, are creating a surge of real estate investors who are best described as being “in between.”
The borrowers in need of middle-market financing — usually owners of commercial and multifamily assets valued at between $500,000 and $7 million — can meet many, if not most, of a traditional institution’s underwriting requirements. They seem to fall short, however, in getting approvals at that level.
When they turn to private lenders, they are well-qualified, if not overqualified, for a loan and expect, erroneously, to get better than the typical interest rates on hard money.
“ Banks and institutions are lending as they always have to
large core clients in real estate, but they are challenged in meeting
the midsize-to-small real estate investor’s growing demands. ”
Among other things, these borrowers’ chances of finding affordable financing are affected by the $230 billion in loans supporting commercial mortgage-backed securities (CMBS) that are maturing over the next two years — as estimated by Trepp LLC. Office and retail CMBS loans account for about two-thirds of that figure, according to Trepp, and multifamily represents the next largest category of maturing CMBS loans.
Not only does this huge CMBS volume coming due mean more borrowers are asking their banks, brokers or private-lenders for a financing solution, but it also increases the banks’ loan-servicing obligations. Those institutions, quite logically, will be more responsive to their long-term clients and well-positioned new ones, than to small-cap borrowers and their less profitable loans.
In today’s post-recession banking environment, regulators have increased the scrutiny, criteria and reporting requirements for most lending. That has increased the workload for many traditional institutions across the same amount of ordinary loan volume. As a result, banks simply are unable to meet the financing needs of every type of lending customer.
Bank staffing and underwriting capacity are under pressure. For a middle-market borrower, there’s often a special situation or unique circumstance that goes with the loan, and institutions are less inclined or less able to listen to the “story” behind a borrower’s loan application. In addition, some institutions simply have cut back on staffing and the volume of funds available. That has a compounding negative effect on small-to-midsize loans or special-circumstance borrowers.
Loan terms and scenarios
Terms offered by private lenders specializing in middle-market bridge-loan products vary from company to company, but there is a range that brokers and their clients can expect when they seek alternatives to bank financing. Typically, they will be offered loan-to-value ratios of 65 percent or lower, interest rates in the mid-to-high single digits, a loan term of one to three years, no prepayment penalty and a flexible capital structure.
Owner/investors can use middle-market bridge loans as an accelerated exit strategy in which a prepayment penalty would be onerous. It’s increasingly common for real estate investors to find out, too late, that the lending climate has changed for their traditional financing sources. That’s a common realization among owners facing CMBS maturities who want to take advantage of improved market conditions to reposition their assets to higher and better uses, but have not worked with their lending institutions in quite some time.
Those borrowers find that under current market conditions, what they once considered normal underwriting and turnaround times are no longer available. By turning to private lenders that specialize in small-cap borrowers with good credit, they can often work out interim financing — a two-year loan, for instance, at a single-digit interest rate with no prepayment penalty — which solves their near-term capital crunch and provides breathing room for repositioning.
The same type of lenders can be useful to investors looking to restructure the debt on multiple properties in a portfolio, a not-uncommon desire among owners of diverse holdings in retail, industrial and office buildings.
Owners of multitenant properties, for instance, often need refinance loans, but also have plans to change the use of the properties in the future. A long-term commercial loan with a traditional prepayment penalty will not meet that borrower’s needs because of the plans to change gears on the overall site within a year or two. Again, with some shopping around, borrowers can arrange shorter-term private loans at single-digit rates, with no prepayment penalties.
“ Again, with some shopping around, borrowers can arrange shorter-term
private loans at single-digit rates, with no prepayment penalties. ”
Owners of multiple properties also can use those assets to find affordable loans to finance a partner buyout. The health of one asset is often strong enough to provide financing for the partner or partners seeking to exit multiple-property investments, although such deals seldom fit banks’ lending criteria.
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Many creditworthy borrowers don’t even know they are in the new gap between unresponsive banks and expensive hard money lenders until they go to their traditional lenders and hit a roadblock. The traditional institution may have the best of intentions of trying to arrange a loan, but regulatory requirements get in the way.
These small-cap borrowers also may find that the pool of bank capital has all but dried up through increased demand, increased capital-ratio requirements and greater loss-reserve mandates. For originators and borrowers, it is worthwhile to look for private lenders interested in — and capable of — providing complex underwriting at attractive rates with the flexibility of a private loan.
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