Since the great recession of 2008, commercial banks, insurance companies and other traditional lenders for commercial real estate have become much more conservative in their underwriting of financing for commercial real estate. Banks, the traditional source of construction financing, have recoiled from lending under the impact of regulations including Tier 1 capital requirements and HVCRE (High Volatility Commercial Real Estate) regulations within the Basel III capital requirement. As banks continue to fade from real estate lending, players within the real estate industry have seized the opportunity to fill the void. The combination of tightened regulations, increasing borrower demand, and the mounting interest by new entrants to the world of commercial financing, have allowed alternative lenders to become an active and significant player in the field of real estate finance.
Bank Lending on the Decline
Over the last few years, expanded regulation has had a significant impact on the banking industry. Banks, facing greater constraints, have had to increase rates and fees. As the major financial institutions retreat from real estate, developers are increasingly looking to non-traditional sources for capital, as they are not constrained by the same regulations. Gregg Winter, founder and Managing Partner of W Financial Fund, acknowledged, “There are a limited number of banks (most of which will require some level of personal recourse) still offering lower-leverage construction loans for solid sponsors with a strong track record. However, the HVCRE rules have thrown a monkey wrench into the works by restricting the amount of imputed equity that banks can allow to count towards a sponsor’s equity requirement. This raises the bar to qualify for a construction loan even higher. Without a substantial balance sheet and a long and successful track record it’s much harder today for a new and upcoming developer to obtain bank financing. The banks much prefer to make successive loans to a handful of reliable developers that they already know and are comfortable with.”
A Constructive Solution
Real estate construction activity has increased every year since 2009, reaching $1.113 trillion in 2015, according to the U.S. Census Bureau. As traditional lender financing options diminish, many developers are looking to alternative sources for benefits beyond availability. The alternatives can be more flexible, less stringent, and the only option in some cases. Winter added, “Private lenders and funds are pricier but they are able to be more aggressive than banks and may be more open to working with new developers. They are also not constrained by the HVCRE rules. The private fund can often bring a lot more to the table than just money in partnership with the up and coming developer."
Many within the real industry welcome the transition to alternative lending as there are many substantial benefits. Eran Polack, CEO-NY & Co-founder of HAP Investments, a development company of residential rental and condominium projects in New York City, prefers to have most of his construction projects financed by alternative lenders. He recently stated, “While the costs for financing are higher, these lenders are often more reliable, flexible and easier on underwriting and documentation. In many instances these private lenders offer higher proceeds and leverage as well as flexibility and the ability to close the transactions in a shorter period than a commercial bank.”[1]
Each and every week, new lenders from the private equity, public and private real estate corporations as well as real estate owners/developers are entering the field of providing alternative financing for commercial real estate. Construction financing, especially for condominiums, hospitality and special use projects, is the most sought after alternative financing. In a previous discussion of lending trends, David Heiden, Managing Partner of W Financial Fund LP, stated, “We have seen a sizeable increase in the number of requests for construction financing as banks have decreased the volume of construction loans they originate. Over the past few years, construction financing for a number of boutique and limited service hotels in the outer boroughs has been financed by private equity firms as opposed to traditional commercial banks.”
Lines Blur between Borrower and Lender
The current landscape has created an environment for developers to evolve into lenders. Developers see themselves more as partners; lending allows them to invest in a peer’s project with lower risk. Meanwhile borrowers prefer to work with developers for the added value: their real estate expertise, flexibility and ability to move quickly. Accordingly, the chairman of a fourth generation real estate owner/developer, who prefers to remain anonymous, noted, “Developers who are successful and worthy of securing financing from the banks are now in turn becoming the alternative lender. In certain instances these lenders are more interested in the borrower possibly defaulting on the loan and allowing them (the lender) to take over possession of property at a discounted price.”
In addition to ownership and development, RXR Realty has recently expanded into alternative lending for various asset classes. As reported in the January Real Deal, RXR provided $163.2 million in mezzanine financing for Extell Development’s One Manhattan Square residential condominium development–supplementing the $300 million they previously provided for the project in August 2016.[2]
Likewise, Fisher Brothers, one of the pre-eminent owner- developers of class A office buildings and residential properties, has increased its exposure in real estate financing as an alternative lender. As reported in the February Commercial Observer, Mr. Fisher commented, “We have been an active investor in debt for many years. We see a void in the market, because we’re operations, we’re not CMBS (commercial mortgage backed securities) investors. We’re not trying to just buy pools of debt. We’re really making mezzanine loans on assets that we can underwrite. We take an equity approach to lending because it’s our money. We see that has proven to be quite attractive to first mortgage lenders and sponsors. We’ll go as low as $5 million, and as high as $80 million, but we think there’s a real sweet spot in that $10 million, especially for transitional assets,” he added.[3]
One of the newer entrants to the expanding list of alternative lenders is the Moinian Group with the launch of Moinian Capital Partners, a lending division that will provide commercial real estate loans starting at $25 million. According to their press release, the entity will provide a full spectrum of debt products from senior mortgages to mezzanine loans, preferred equity, and construction loans. The company has already closed on more than $300 million in Manhattan and the boroughs.
With banks reeling from the regulatory impact, alternative lenders are in position to pick up the slack when it comes to commercial real estate, development and construction loans. Non-bank lenders are able to finance real estate development similar to banks but without the regulation, liabilities and risk. Borrower demand continues to escalate, breeding competition among lenders. However, developers have the edge in alternative lending for commercial real estate due to their existing relationships, established experience and ability to deliver quickly. As the alternative lending industry continues to grow, they are becoming less and less the alternative solution.
1 The Stoler Report: Residential Development in the Region
2 Real Deal “Extell’s One Manhattan Square is fully financed following new RXR infusion”
3 Commercial Observer “Winston Fisher Talks Marathons, Mezz Debt and Fisher Brothers’ Pipeline”
