Loan officers at U.S. banks reported tightening their lending standards for commercial real estate loans over the last year, the Federal Reserve said on Monday in a report that could heighten concerns about the outlook for commercial real estate.
Officials at the U.S. central bank, including Boston Fed President Eric Rosengren, have warned that a run-up in commercial real estate loan prices could amplify any future economic downturn.
On Monday, the Fed said in a quarterly report that standards for overall businesses appeared largely unchanged during the first quarter. But in this latest poll of senior loan officers, the Fed included special questions on obtaining a commercial real estate loan over the past year.
U.S. banks, in describing why they were tightening standards, cited “a less favorable or more uncertain outlook for CRE property prices, capitalization rates and vacancy rates,” the Fed said in its report.
The Fed is putting a bigger focus this year on the commercial real estate loan in its annual “stress tests” of how well big banks could weather financial turmoil.
While alternative lenders are getting more attention, they are still relatively small players in the massive arena that is the commercial real estate lending world. According to a statistic from the Mortgage Bankers Association, they held 3.1 percent of the nearly $3 trillion of outstanding mortgages last year. How does that compare to other lending sources?
- Banks held a 40.4 percent share, up from 38.6 percent in 2015;
- The housing finance agencies—Freddie Mac and Fannie Mae—came in with a 17.6 percent stake;
- CMBS seized a 15.5 percent share; and
- Life insurance companies held a 14.2 percent stake.
Banks’ relatively heavy exposure to commercial real estate has piqued regulators’ concerns. As such, banks are pulling back, creating more opportunities for private lenders.
According to the Federal Reserve’s recent Senior Loan Officer Opinion Survey, banks reported that they tightened their lending standards over the past year. Lenders increased their spread of a commercial real estate loan, and a significant percentage of banks had reduced their required loan-to-value ratios on land development, construction, and multifamily loans. In most cases, banks had cited the uncertain outlook for commercial real estate and increased concerns about the effects of regulatory changes.
Banks Are “Allocating” The Commercial Real Estate Loan
“It’s not that banks aren’t lending,” explained Stephen Theobald, chief financial officer of Walker & Dunlop. They are effectively rationing their credit by not providing too much financing to any one developer, sector, or geographic area. That has prompted some developers to quickly pay off their construction loans in order to be able to line up new financing for their future projects. Because of this, developers will often turn to private lenders for interim loans that would take a project from construction completion to stabilization.
“Once upon a time, banks were the real estate lenders,” explained Joshua Stein, a New York attorney who has specialized in the sector for more than three decades.
Thorofare Capital, a Los Angeles lender that focuses squarely on the middle market, pointed to that pullback which were the meat-and-potatoes lender to relatively small and mid-sized development projects throughout the United States. They were also the traditional lenders to properties undergoing redevelopment or renovations.
“Before the downturn, they were doing deals for the real estate, not for the banking relationships,” explained Felix Gutnikov, executive vice president of originations for Thorofare. They are typically reluctant to lend now, he said, unless they are able to generate additional business from their clients. That has created pockets of opportunity for Thorofare, which originated $345 million worth of loans last year and expects volume to increase substantially this year, given the 70 percent increase in volume it saw during the first quarter.
Meanwhile, outside of the Trump administration’s efforts to reduce regulations, there is no move among developers and others to push to reduce mandates on banks. So, “the space is wide open” for private lenders, according to Boyd Fellows, who led a team that formed ACORE Capital two years ago after developing and running the conduit-lending operation for Starwood Property Trust.
Dozens of other investment managers have raised capital to lend on a relatively short-term basis. Some have been in the debt space for years, while others typically invested in commercial properties. Arden Group, an opportunistic investment manager from Philadelphia, recently set forth an effort to raise funds that it would use to provide bridge and mezzanine loans against properties undergoing renovations.
The firm has found that banks are no longer willing to provide more than 65 percent leverage against properties after their repositioning. That often puts a restrictions on a developers’ projects, so Arden hopes that they will turn to companies like itself for private financing. Meanwhile, the business continues to make confident investments and finds itself borrowing from other private lenders.
That makes sense, since many alternative lenders got their chops in the industry by investing in properties themselves. So they are familiar with how redevelopments work and the challenges that investors might face.