Real estate debt funds are seeing the pool of lending opportunities widen further as the turmoil in the banking sector creates a bigger void in the financing market.
Credit funds were already gearing up for more activity after a series of rapid rate hikes last year. In March 2022, the Federal Reserve began raising the federal funds rate from 0.25-0.5 percent and it has reached 4.75-5 percent. The rapid rate rise led major banks to pull back on lending across all asset classes, including real estate.
Non-bank lenders expect to get even busier amid continued bank retrenchment following the collapse of Silicon Valley Bank and Signature Bank last month. The bank failures are expected to have major repercussions for the US regional and community banking system, which had previously been a major source of financing for real estate borrowers.
Regional and community banks, those outside the top 25 major banks in the US, hold around 31.5 percent of the $4.5 trillion of US commercial real estate loans, according to research by Cohen & Steers. The approximately 4,600 regional and community institutions hold around 70 percent of all real estate loans held by banks.
Many former customers of SVB and Signature Bank have moved their deposit relationships to the largest money center banks in a flight to safety, market participants told PERE. This outflow of deposits is expected to have a profound effect on smaller banks’ ability to be active in commercial real estate lending going forward.
“Banks really lend on a ratio of deposits, and that is going to curtail their ability to lend,” Josh Zegen, managing principal and co-founder of New York-based manager Madison Realty Capital, told PERE. “That’s going to lead to loan sales, banks shrinking their balance sheets, lender finance opportunities for us to finance alternative lenders and just more availability of opportunities for private credit.”
Additionally, stricter regulatory requirements for smaller banks are on the horizon. Late last month, the White House called for a reversal on Trump-era rollbacks that were in part blamed for contributing to the SVB and Signature Bank failures. Among the proposed rules are requirements for medium-sized banks to hold sufficient high-quality liquid assets to cover expected net outflows during a stress period, and to undergo stress tests once every one or two years.
Values are predicted to fall further amid tightening lending standards. Cohen & Steers has revised its projections from a 10-20 percent decline from peak 2022 pricing to a 20-25 percent drop.
Where the opportunities are
Some real estate debt funds believe they are well-positioned to step into the void left by banks. Non-bank lenders represented 16 percent of commercial real estate loan originations in the first half of 2022, according to data from MSCI Real Assets. In 2012, non-bank lenders represented just 5 percent.
“Today [private credit] is a major institutional asset class globally,” Zegen said. “The amount of money out there to take up some of the void left from the banking sector is much greater than it was.”
Nitin Chexal, chief executive of Palladius Capital Management, an Austin-based real estate equity and debt manager, told PERE that he is seeing more deal flow come across his desk, due to borrowers seeking a certainty of execution, which is difficult to find elsewhere in the market. The deals run the gamut from land and construction to acquisition and repositioning, he said.
A lending gap clearly exists in certain parts of the market, Chexal observed. Hospitality and retail in secondary and tertiary locations are notably struggling, he said, while multiple market sources agreed that office is the most difficult sector to obtain a loan.
Zegen said that Madison Realty would not rule out investing in office but the “bar is very, very high.” Some pockets of the US, such as South Florida, still see strong demand for office because of the migration of new companies and residents to the area.
However, most debt fund managers see good financing opportunities in sought-after sectors like multifamily, industrial and some niche property types, although they typically face stiffer competition on such deals, Zegen said.
Additionally, there will be an opportunity to not only buy distressed loans but to lend to distressed loan sellers as well, according to Zegen.
“It’s generally a senior secured position because I’m financing another lender,” he said. “There are banks that are in the market today doing that, but as the balance sheet of banks shrink, and their ability to lend shrinks, so too will the ability of the banks to do that business, and we’ll pick up the void.”