Because commercial real estate has historically been one of the highest performing asset classes, it has traditionally been monopolized by large banks.
While the big banks still play a major role in financing commercial real estate development and acquisition, the financial crisis has made way for new entrants.
Ever since the crisis, lending regulations have tightened up and banks are thankfully a bit more careful with their due diligence. This tightening of capital by the banks has created a larger market of private money lenders for commercial real estate projects.
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Private debt in commercial real estate
private money lenders cannot borrow money from the federal reserve like the big banks can, they end up managing money for pension plans, high net worth individuals and other investors. These investors are of course looking for a return and will only lend money when they believe they can achieve that. Therefore, interest rates are higher with these loans than they would be if going through a commercial bank.
With higher interest rates and a shorter term to pay the loan off, it is easy to see why big banks are the better option for some borrowers. However, there are several redeeming qualitites of the private money lenders and situations that make them the best available option.
Hard money construction loans
Banks will traditionally ask the borrowers to sign personal guarantees to secure loans. Novice and expert real estate developers alike can be hesitant to sign these guarantees which would put all of their other business and personal assets at risk.
Because private money lenders don’t typically ask for guarantees, many real estate developers see it as worthwhile to pay a few percentage points more on the loan to sleep better at night knowing their house isn’t at risk.
Instead of mitigating their risk by asking for personal guarantees, these lenders will hold the real estate deed as collateral for the loan and lend up to a certain percentage of the properties appraised value. We’ll discuss the concept of “loan to value” a bit more later on in this piece.
How private construction loans work
For the same reason investors are hesitant to sign personal guarantees, many real estate developers don’t want to sign over their personal assets as collateral either. With many private money lenders, it isn’t necessary.
The lender will want to know that they are lending to a qualified developer and will ask to see information on the project and the developers track record. If the lender agrees to fund the project (or part of the project) the money will be given out in tranches.
Making these payments in tranches means that instead of the developer getting all the money as one lump sum, they are first given enough money to do the excavation, once the excavation is completed, they are then given money for the building foundation and framing and so on.
The lenders tranche the money this way to mitigate their risk. If for some reason problems arise in the project, they will likely lose some of their investment, however it won’t be the full sum of the loan.
Because these loans are secured by holding the property itself as collateral instead of the borrowers assets, the lender will liquidate the property if the borrower is unable to meet their obligations of paying back the loan.
Commercial real estate bridge loans
Once construction has been completed, commercial buildings will still need a bridge loan until they are able to find tenants, hire managers and either sell the project or take out a longer term, lower interest rate loan on the building.
These loans are secured to pay-off the construction lenders and provide interim capital until the building is fully leased out.
Because bridge loans are short and carry much less risk than construction loans, the market for bridge lenders is much larger than the market for commercial construction lenders. Most bridge loans are non-recourse and many companies allow for the conversion of bridge loans into permanent real estate loans once the building is stabilized. They are often willing to give better financing terms for this scenario.
Loan to cost for commercial real estate development
As mentioned previously, many of the private money loan programs discussed previously are non-recourse, meaning they hold the property itself as collateral.
Because something can go always wrong with a real estate development, lenders are not guaranteed repayment. To help in mitigating this risk, lenders will only lend out as much money as they believe they can get back.
Interest rates and term for real estate development loans
Because the lenders are trying to get a return on their investment and they take on more risk than the big banks do, they charge higher interest rates and typically lend for a shorter term.
The trade off for this higher cost is that the money may be available to borrowers that have been declined by the banks, the borrowers may be able to get loans without personal liability and the capital can often times be loaned out quicker than going through a bank.
Commercial real estate loan companies
Mid-Market List offers a database of commercial real estate loan companies. We offer this for free as a way of getting in front of more developers, project managers and real estate investors. We also develop lists of law firms, investment banks and private equity companies that operate in each industry.
Each commercial lending company works differently and has different criteria. To find the right lender for your specific situation, submit your project information to our Get a large commercial real estate development loan page.
Construction Loan Property Types
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