Overlapping Capital Sources Mean More Choices, More Complexity for Borrowers
Everyone knows there’s an abundance of capital in today’s commercial real estate market—and while that’s generally a good thing for borrowers, it can also mean more complexity. As more financing sources compete for deals, there’s greater overlap as the capital stack is put together. Banks and institutional capital are becoming more aggressive, and a growing number of domestic and foreign private equity and non-bank debt funds are also chasing yield.
We also see lenders that traditionally compete with one product are entering other areas – for example, life companies that typically chased longer-term mortgages are now doing shorter-term bridge lending and vice versa for banks.
In short, it’s a “Disneyland for borrowers” – but everyone is rushing toward the same ride.
Key Learning Points:
- Banks, institutional lenders, private equity, and debt funds are seeking yield and competing for loan volume.
- Spread compression and term changes are creating overlap between sources of capital.
- Borrowers are seeking more flexible capital causing a bubble in the bridge loan space.
- Buyers have access to more capital but are finding it challenging to source good deals.
- Borrowers should consider their end goals and loan servicing needs when choosing a capital provider.
Spreads Compressing = Capital Providers Playing in New Spaces
Capital sources are converging. A deal that in the past would likely have been commercial-mortgage-backed-securities (CMBS) could now be funded by a life or pension company or even on a bank’s balance sheet. Terms for an aggressive CMBS loan are so compressed that they are not far off from a life company loan. This loan type convergence has also coincided with borrowers looking for more flexible capital, creating a bubble in the bridge loan space.
On the private capital side, spreads have compressed 100 to 150 basis points over the past 18-24 months, outpacing the increase in the LIBOR benchmark interest rate. As debt funds provided more competition to the banks, the banks are trying to replenish loan runoff, and have reacted by dropping their spreads. Banks have become more aggressive in particular on pricing for deals, contributing more liquidity to the market, and debt funds have continued to compete on loan proceeds, still at competitive spreads. Furthermore, bridge loans are taking the place of CMBS as the most crowded space in commercial real estate.
Term is another area of great change. Where there used to be greater delineation between fixed and floating loans, and where to source them, now everyone has multiple “buckets” of capital. Banks are offering 10-year fixed-rate mortgages at leverage rates that are similar to life companies. Debt funds are making seven-year term deals, and doing construction lending on deals that would have been a bank loan previously. For example, in a recent KeyBank deal in Seattle, a $60 million refinance of a multifamily building was completed with a life insurance company on a five-year term instead of being placed with a debt fund or a bank bridge loan.
What This Means for Borrowers
While it’s an attractive time to be a borrower, for those seeking acquisitions on the equity side, it can be a challenge to find good product to buy at yields that make sense. Just as lenders are chasing debt, borrowers are chasing acquisitions, and an influx of buyers domestically and internationally is driving competition up and driving capitalization rates down.
Borrowers should ask themselves some strategic questions before entering into a lending relationship.
- What is your end game? If your company is well-capitalized and chasing an all-in yield, the decreased capitalization rate isn’t changing your strategy, but for others it’s tempering the market. Smaller regional buyers are starting to pause or be selective in the deals they pursue. Others are taking floating-rate loans to maintain flexibility, giving them the ability to opportunistically sell the property in a few years free and clear of debt.
- What needs can come up during your term – and can your capital provider service your loan? With some lenders moving outside of their core competency while chasing volume, owners are finding that they may not have the infrastructure and willingness to service and manage the loan. For bridge loans particularly, borrowers must work with a trusted lender to be able to execute on their business plan. For example, sponsors may want to future-fund redevelopment costs in a value-add play or need to add amenities to sign a tenant – an investment that can’t be directly tied to cash flow. A trusted lender should offer the flexibility to make those business executions work.
- How involved will your lender be operationally? Borrowers don’t want lenders calling the shots—and most of the time, lenders don’t, either. Banks tend to trust the sponsor, while private capital is typically provided by an executive team who are also owners. While there may still be trust between lender and borrower, private sources of capital tend to become more involved in operational decisions and express more opinions on how the property should be managed. This involvement can lead to frustration and increased layers of approvals during processes such as lease negotiations.
Putting the Capital Puzzle Together
As lines between capital sources become less clearly defined, putting together the capital stack for a deal can be more complicated. It’s more important than ever to pick the right teammate that understands your business plan and how to achieve it. KeyBank’s comprehensive, national platform brings together bank balance sheet, bridge loan, debt fund, life company, CMBS, and agency financing with a relationship-oriented experience.
To learn more, contact Josh Berde, SVP, Originations at firstname.lastname@example.org or 425-709-4340.