We are in the midst of the most challenging credit environment in a generation. Many lenders have closed their doors forever and virtually all have tightened their lending standards. Even borrowers with clean finances, good credit and healthy down payments are finding it difficult or impossible to get their projects funded. What a difference a year makes.
We’ve been living in an era of cheap money for a-long time now. Interest rates and marginal income tax rates both began to moderate and trend down as America and the Federal Reserve embraced the supply side of the economic equation. But cheap money does not, necessarily beget copious amounts of lending even if willing borrowers abound.
Look at our situation right now; rates are so low that when you factor in inflation money is practically free. There are plenty takers willing to invest in commercial property or undertake a new development project but the banks aren’t funding loans.
It is not the cost of money that matters, it’s the flow. The key to a vibrant credit market is liquidity. Most financial Institutions have no real interest in holding the loans they write.
They could hold on to their commercial mortgages and earn some interest but so what?
They could earn interest by buying Government bonds and Government bonds have no risk. Most financial institutions either sell or borrow against their mortgages so they can get more money to loan out again or to invest in other core business activities.
What has happened recently is that the secondary market for mortgages seized up. No one was willing to buy mortgages so, if banks wrote them they were facing the prospect of holding them and, thus, tying up their capital at substantial risk. They opted not to write them. No loan buyers in the market, no loans. It doesn’t matter how low rates go.
To facilitate the efficient buying and selling of mortgages Wall Street turned them into bonds. They took hundreds of loans at a time, of all different quality, bundled them and called them collateralized mortgage obligations (CMO). These CMOs were bought and sold and repackaged and borrowed against again and again, The CMOs included good mortgages and poor mortgages and even some dreaded “sub-prime” mortgages. Eventually, no one could figure out who owed what to whom and what actual property was backing what bond. Investors stopped buying. In very short order volume in the secondary mortgage market dropped by more than 80%. No loan buyers, no loans.
So what is a borrower to do? At my firm, MasterPlan Capital, I talk to borrowers every day. I can assure you they don’t care about the CMO market or how hard it is to find buyers for mortgage paper now-a-days. They want their deal funded as-soon-as possible credit crunch or no credit crunch.
I’m a commercial real estate investment banker; it’s my job to get my clients the money they need quickly, efficiently and on the best terms available. I had to find funding sources and investors who were un-phased by the credit market’s liquidity problems.
The answer should be obviously to professionals and borrowers alike; find lenders who don’t sell their loans.
A mortgage lender who holds the loans it originates is wholly unaffected by the fact that there are few buyers. He just doesn’t care. There is a name for these unique lending companies, there’re called “portfolio lenders”. They issue mortgage loans and they keep them in their portfolio, collecting interest over the life of the loan and receiving their principle back at maturity. Portfolio lenders have the freedom to be flexible and write loans they want to write rather than writing a loan that will be sure to appeal to a very discriminating debt purchaser. They close deals much faster and with less paperwork and less documentation than lenders dependent on the whims of the market. Portfolio lenders are still in the game while the big national banks, insurance companies and Wall Street sit on the sidelines and wait for the market to become liquid again.
I’ve been able to identify and establish relationships with quite-a-few portfolio lenders in several segments of the financial industry. By turning to this special group of money sources I’ve been able to secure approvals for clients who simply could not get financed through traditional outlets.
I’ve had great success with hedge funds, real estate investment trusts (REITs), and private lenders.
Hedge funds crave risk while others shun it. They pride themselves in being aggressive and having the ability to see the value in a deal when others can’t or won’t. These hedge funds are largely unregulated and can invest wherever they see fit. Best-of-all hedge funds are flush with cash. They have tons of money immediately available and can make decisions and close deals in just days. Once you have identified a fund that has a taste for real estate and a desire to make deals all you have to do is bring them what they want. And once you’ve made them money in a deal you’ll have a funding source for life.
REITs are similar to hedge funds in some respects but they are often publicly traded and thus lack the flexibility inherent in hedge funds. A REIT is a specialty company that must, by law, operate in the real estate sector and distribute substantially all of it’s income to it’s shareholders. Most REITs directly invest their assets in income producing real estate such as apartment buildings, retail centers, hotels or office buildings. But some are in the business of making loans. The trick is to find them and then to come to understand their lending criteria. By and large they are portfolio lenders so if your building or development project falls within their investment parameters you can close loans all day regardless of the credit environment.
Private lenders are individuals or privately owned business entities that seek high yields on their investment capital by lending it out against commercial real estate. Once called “hard money” lenders they are now main-stream and represent the fastest growing segment of real estate finance. There are literally hundreds of firms that hold themselves out as private lenders. The trick is knowing which ones will truly come through with the money on closing day. Working with a legitimate private lender can be extremely rewarding, they identify with property owners and investors and write loans based on the merits of the deal not a set of Government imposed guidelines. A good private lender on your team is like money in the bank. But, beware, a disreputable private lender can ruin your deal and your reputation.
When seeking financing for commercial real estate I suggest you start with a simple but important question. Ask the lender if they sell their loans or portfolio them. If they tell you they hold their loans for their own account in their own portfolio, you’ve found someone who can afford to ignore the credit crises and write you a check no matter what the market happens to be doing.