By Steve Belleville MBA, Redwood Mortgage
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Commercial real estate lending is clearly not a one-size- fits-all sector, and one slice is decidedly under-served as a result of recent and ongoing market trends: The middle-market bridge loan. Banks and institutions are lending as they always have to large, core clients in real estate, but even they are challenged in meeting the mid-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 in helping investors with special needs outside traditional lending, such as with short-term, double digit interest-rate solutions but it doesn’t always have the loan product or sophistication to be competitive with single-digit interest rate loans.
In-Between Sector Feeling the Squeeze
Market forces are creating a surge of real estate investors who are “in between.” They can meet many if not most of a traditional institution’s underwriting requirements but seem to fall short in getting approved; on the flipside, if they seek typical private-loan products, they are well-qualified if not over qualified for a loan and expect to get better than the typical interest rates of hard-money.
The middle-market between these two lending sources is growing, for several reasons:
— $230 billion in CMBS maturities over the next two years, as estimated by Trepp LLC, is a crunch of new-credit requirements. According to Trepp research, office and retail represent more than 63% of the approximately $230 billion in CMBS loans maturing in 2016 and 2017 with multi-family making up the next largest property type maturing. Not only does that mean more borrowers asking their banks, brokers or private-lenders for a solution, but it’s also creating a servicing bandwidth problem among banks. Institutions quite logically will be more responsive to their long-term clients and well positioned new clients.
— Banks and institutions have tightened their lending criteria. In today’s post-recession, more-stringent banking environment, regulators have increased the scrutiny, criteria and reporting requirements for most lending, and have increased the workload for many traditional institutions across their same amount of ordinary loan volume. Banks simply are not able to meet the financing needs of their client base.
— Staffing and underwriting capacity are under pressure. For middle-market borrowers, there’s often a special situation or unique circumstance that goes with their loan, and institutions are less inclined or less able to be responsive. What’s more, some institutions simply have cut back on staffing and the volume of funds available. That has a compounding, negative effect on small to mid-size loans or special-circumstance borrowers.
What are Commercial Borrowers Seeking Middle-Market Bridge Product to Do?
Clearly many traditional institutions and private-lenders are working to serve this burgeoning demand, but borrowers are putting forth their own litmus test for lenders. When delayed or turned down by their banks, borrowers and their brokers can look for certain characteristics of middle-market bridge loan products, and of the lenders behind them. Typical aspects include:
— low LTV such as 65% or lower
— mid to high single digit interest rates
— generally a shorter duration loan, 1- 2- or 3- years
— no prepayment penalty
— more nimble capital structure
What do some middle-market bridge loans scenarios look like? Here are examples.
1) Owner/investors with an accelerated exit strategy, in which a prepay 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 sources. An owner of a commercial property in Northern California was facing a CMBS maturity, and also wanted to take advantage of improved market conditions to reposition the asset to a higher and better use, but hadn’t worked with their institution in quite some time. After trying to get financing and realizing the normal underwriting and turnaround time wasn’t working, they turned to a middle- private lender. Longer-term institutional capital is seen as a take-out strategy, but an interim two-year loan at an upper single-digit mortgage rate — with no prepay penalty — solved the near term capital crunch and provided breathing room for the repositioning.
It’s increasingly common for real estate investors to find out, too late, that the lending climate has changed for their traditional sources. An owner of a commercial property in Northern California was facing a CMBS maturity, and also wanted to take advantage of improved market conditions to reposition the asset to a higher and better use, but hadn’t worked with their institution in quite some time. After trying to get financing and realizing the normal underwriting and turnaround time wasn’t working, they turned to a middle- private lender. Longer-term institutional capital is seen as a take-out strategy, but an interim two-year loan at an upper single-digit mortgage rate — with no prepay penalty — solved the near term capital crunch and provided breathing room for the repositioning.
2) Owners of properties with multiple components needing to restructure the asset.
Commercial real estate investor needed to restructure the debt on multiple properties in a portfolio, which isn’t that uncommon when a real estate investor has a diverse portfolio consisting of retail, industrial and office buildings. In a recent transaction, the owner of a multi-tenant property needed a new loan but also had plans to repurpose the property to attain higher density as a mixed use with residential. A long term commercial loan solution with traditional pre-pay penalty would not meet the borrower’s need because of plans to change gears on the overall site within a year or two. A shorter private loan was arranged — at a single-digit rate and with no prepay penalty.
3) Change in ownership structure, or facilitating a partner buy-out.
Rising real estate values can trigger change among the investment strategies of partner-held real estate. For example, a Southern California commercial property was refinanced recently in order for an investor to exit the two-property project. The health of one asset was strong enough to provide financing for the partner buy-out and for improvements to the second asset, thanks to creative financing from a middle-market bridge lender. Underwriting criteria were fundamentally similar for the middle-market private lender which was able to provide added flexibility to a situation that just didn’t fit the boxes of the banks’ criteria.
Loan, Be Nimble, Loan Be Quick
Many borrowers don’t even know they are in this new ‘gap’ until they go to their traditional lenders and hit a roadblock. The traditional institution may have the best of intentions trying to facilitate a loan but more onerous regulatory requirements get in the way. Or, the pool of bank capital has all but dried up through increased demand, increased capital ratios and greater loss-reserve regulations, among others. Brokers, originators and borrowers facing these challenges should test their lender relationships as well as new sources for finding the best fit in middle-market bridge situations. Private lenders, especially those who can up their game to provide complex underwriting and attractive rates with private-loan- like flexibility, are well positioned to help middle-market bridge borrowers, and thrive along with them.
Steve Belleville is Director of Sales and Marketing for Redwood Mortgage. Founded in 1978, Redwood Mortgage is a second-generation family-held firm with 35 years of experience in arranging and funding middle market bridge and private mortgage loans in California. Based in San Mateo, CA, the firm and its affiliates have arranged nearly $2 billion in loans and currently manage assets of over $350 million. For more information, Steve can be reached at email@example.com., or visit www.redwoodmortgage.com