How the Real Estate Lending Landscape has changed from 2021 to 2023.
There are more toxic debt deals than new deals being originated.
2021 was one of the busiest years for refinancing real estate debt and acquiring real estate at all-time high valuations. Borrowers could walk in to almost any bank or lender and dictate the terms they wanted, force them to give them the lowest rate with the cheapest cost, and the banks and lenders would do just that. Money was flowing like an unstoppable river, paving the path for many real estate investors to flourish and use their assets like an ATM to print money, rinse, and repeat.
2023. The exact opposite. Imagine looking up into a faucet, or looking down at a hose and it being dry, empty, with maybe one drip within sight. Lets first take a look at banks. Banks have the majority of their capital tied up into sub 4% mortgage rates while most mortgage rates today sit near 7.5%. This a 3.5% deficit. Most of this debt is coming due in 2025, 2027, and some not until 2031. Most commercial real estate loans are done in 5 year or 7 year terms, which means a reset or refinancing will take place based on todays current rates, or some have caps at 2% higher than original rate. Meaning, if you have a 3.5% rate, and a 2% cap, after year 5, your rate can go to 5.5%. Your payment will be up nearly 50%, and odds are your rents won’t be. Yes, you will have paid down some of the loan balance, but will it be enough to cover the debt service? Probably not. Borrowers should be preparing now for “Cash in” refinancing to take place, where they bring new money into the deal to pay down the existing loan balance.
“But I have a ton of equity. The property appraised for $16,000,000 just 2 years ago” one borrower said to me. So I took out my spreadsheet and ran through the updated cash flow analysis and based on today's 2023 rents and expenses, the property on paper was only worth about $12,200,000. “What? How?” the client asked. Well cap rates are up because rates are up and you can put your money in the bank at 5.25% right now, so your real estate value has dropped accordingly. If rates go back down, your asset value will certainly recover a little bit, but if rates don’t go down to the same 3.5% rate you have now, and rents do not rapidly continue to increase 10% or so every year, you may never see the valuation again.
Private lenders and funds are sitting on more capital than ever right now. The only problem is that there aren’t very many doable deals in the market. Most loans are not getting paid off and construction projects are still taking a long time to complete, which means lenders are unable to raise their rates or recycle their capital which is the name of the game. Due to higher bank rates, lenders are unable to properly exit bridge loans they did which is causing them to pivot their debt from first position to converting the debt to preferred equity or Mezz debt, which I believe is going to be the most lucrative opportunity in the market for the next 2–3 years.
There is said to be $1 available for every $3 being asked for right now in the private capital markets. While most equity players do not do both debt and equity, word is on the street in the equity markets that all of the monies are tied up in past projects and can’t be accessed, which means an opportunity to raise new funds is critically needed. New players will be emerging but my only concern is their experience level in underwriting deals in today’s market environment. To summarize the above, lenders and equity providers can be as picky as they want on deals due to the influx of NEED in the market place, which also goes hand in hand with driving up their ROI or interest rates.
The sentiment has certainly shifted to “Cash is king” right now and those that deploy capital strategically with the right legal team and to the right borrowers will be able to capitalize on these market conditions. While there is a lot of uncertainty and unknowns in the market that we are facing, there will always be great investment and lending opportunities.
Next up, a new wave of defaults is hitting the market. How will this impact the commercial real estate market? Learn the Office to Residential apartment conversion game, as this will make people more than enough money to retire if properly executed.
Last year we succesfully funded the below transaction in under 30 days of which our client purchased this old half vacant office building in Bridgeport, CT, and we gave him acquisition + construction funds to turn this deal into a 110+ unit residential apartment building.
