Private Lending Impact on CRE

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Regional banks traditionally have been one of the biggest lenders in commercial real estate. However, regional banks' appetite for lending has soured due to increasing regulatory demands, rising delinquencies and falling underlying valuations. Private lenders have been raising large funds to take advantage of this disruption in the market.

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Regional banks have many low interest loans on their books that they can't offload without taking a big hit to earnings. The only way to sell low interest loans in a high interest rate environment is to discount the value, and they can't afford to do that. Private lenders have stepped in to take advantage of this situation and help banks by essentially selling them insurance (technically called Synthetic Risk Transfer) on a portion of the loan portfolio. Having this insurance, in the eyes of the regulators, is the same as selling the loans, so it is a big benefit to the bank. The bank pays an annual premium that is negotiated with the private lender. If the private lender has done a good job of underwriting the loss potential on the insured book of loans, they can make a very attractive return for their investors.

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Private lenders are also stepping in to help commercial real estate investors who can't get traditional financing. Private lenders are providing bridge debt to investors who need capital and time to execute their plan. If the owners can stabilize the property and improve the valuation, they can then look to refinance at lower rates and better terms. This is a very profitable situation for private lenders as they charge origination fees and, in some cases, interest of 12-15%. In most cases they take a preferred equity position right behind the first lender. This means that they will get their money out before the limited partners see a dime.

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At first blush this may seem like predatory lending, but these investors are taking risks and deserve a return on their investment. There will always be a need for private lending, but today, private lenders are taking a much larger and important role in commercial real estate. Over time, we believe there will be a reversion to the mean, and banks will once again be in a competitive position to retake some of the ground lost to private lenders.

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