If Banks Are Still Lending, What’s The Real Reason Behind The Growth Of Debt Funds?
A decade ago alternative lenders, or debt funds as they are more popularly called, were known as the last option for borrowers looking for capital to get a project off the ground. Today these funds are standing toe-to-toe with some of the country's largest banks, and it is not because traditional lenders have ceased to take on commercial real estate debt.
Banks are still funding commercial real estate projects, but they are doing so with increased caution. Traditional lenders have become more strategic in how they lend to commercial real estate players, making sure not to allocate too much of their credit to any one developer, sector or geographic area. This shift has led alternative, non-bank lenders to step in and fill the gaps with mezzanine loans, bridge financing and other debt. Experts say this trend may accelerate as the cycle matures and builders become more selective in the equity deals they pursue.
JCR Capital Managing Principal Jay Rollins said talk of banks no longer issuing commercial real estate loans as a result of tighter lending standards has been vastly overblown. He said that sensationalized narrative has acted as a catalyst behind the growth of alt lenders.
“I think banks cutting back on their commercial real estate lending has been an urban myth propagated by media, and everyone has jumped on to it. With the exception of construction loans that have been cut way back, we are not seeing banks be less aggressive in the market,” Rollins said.
Instead, Rollins said the rise of alt lenders is coming from the limited partnership community, which is looking for better ways to put its money to work as the cycle matures.
“[They] have come to the conclusion that the real estate cycle is long in the tooth and there would be better risk-adjusted returns for them [by] doing debt,” Rollins said. “Therefore they are financing more debt providers, which means more funds that are doing debt.”
The Rise Of Alternative Lenders
JLL Capital Markets Managing Director Aaron Appel said alternative lenders are no longer the black sheep of lending options, citing Mack Real Estate Group, Starwood Property Trust and Mesa West Capital (all of which were represented at Bisnow’s National Finance Summit on June 22) as examples of primary sources of capital in today’s business.
“I don’t think necessarily they’re alternative sources anymore. If you add up the total billions of dollars of commitments that they agreed to fund in the last 12 months, I think they’ve rivaled some of the biggest commercial banks in the country, including Bank of America and Wells Fargo,” Appel said during the event. “It has certainly become a more primary source of capital.”
The country’s top five non-bank lenders — Blackstone Group, Mesa West Capital, Starwood Capital Group, TPG Capital and Mack Real Estate Credit Strategies — together funded $20B in bridge loans in 2016, according to Trepp data.
Even some of the country’s top developers are expanding their businesses to include debt to fund their peers’ projects. Developers like White House adviser Jared Kushner’s family business, Kushner Cos., Moinain Group, Related Cos. and SL Green Realty. These players have increasingly shifted to the debt side of the business as good deals on the development side grow harder to find.
Aggressive Competition Impacts Bank Lending
In a Federal Reserve survey discussing lending practices, major lenders cited the uncertain outlook of the industry as a growing concern.
This survey, which the Fed conducts quarterly, takes the pulse of up to 80 of the largest domestic banks and 20 U.S. branches and agencies of foreign banks in the country. The latest survey taken in April 2017 revealed commercial and industrial lending standards from banks of all sizes remained unchanged in the first quarter of the year. In fact, a moderate number of domestic banks surveyed have eased their standards due to aggressive competition from other banks and alternative lenders.
Those that tightened their standards in Q1 cited several causes for concern, including “a less favorable or more uncertain economic outlook; reduced tolerance for risk and increased concerns about the effects of legislative changes,” the report reads.
“What I think is interesting about our space is how much it has changed over the past seven to eight years. I think the fact that alternative lenders are accepted as a form of borrowing today from true institutional clients is the biggest change,” Mesa West Capital principal of the East Coast office Raphael Fishbach said during Bisnow’s finance summit. “Now all of us are dealing with top-tier institutional clients and we continue to grow that business. … I think we compete on every deal whether it is among ourselves or the banks out there becoming accepted in both the borrowed and loan community.”