For short-term funding for commercial real estate projects like multifamily buildings, shopping centers, construction loans, and many other property types, real estate debt capital helps connect borrowers (often developers) with lenders. Real estate debt funds now fill a modest but lucrative gap in the commercial real estate lending market.
After the housing crisis of 2008, real estate debt capital began to take off. Commercial real estate credit dried up at the time because traditional lenders like banks were experiencing liquidity problems. Then, additional limitations on the kinds of loans that conventional lenders could originate were imposed by post-crisis regulation. To fill this gap and start lending to investors and companies in commercial real estate, several private lenders, including real estate debt funds, stepped in.
Although banks, agencies, and CMBS (Commercial Mortgage Backed Securities) lenders are once again offering commercial capital, many traditional lenders have not yet pursued borrowers in need of bridge or construction loans, leaving that market in the hands of debt funds and other private financings. In the sweet spot where borrowers need loans that are typically less than $100 million but too big for small lenders and too small for non-bank institutional lenders, debt capital offers loans.
Debt funds can provide the capital a company needs more quickly than a traditional lender, thanks to streamlined processes. This agility can be especially helpful in the real estate industry, where quick closings are typical and missing a funding deadline can have disastrous results.
Real estate capital companies make their money from interest on borrowed funds and, in the event of a default, from taking ownership of the underlying collateral for the loan. The fund charges borrowers interest rates that frequently start at 9%+ and can change depending on the state of the market. Rates get fixed, and payments get made each month. Due diligence, origination, servicing, draw, modification, extension, and exit fees are examples of borrower fees for loans. These non-interest-based fees may be given to investors in complete or in part, depending on the types of funds.
From $5 million to $150 million or more may be borrowed. It provides short-term loans, such as terms of one to three years. For the most part, the LTC (Loan Cost ratio) or LTV (Loan Value ratio) for loans is not greater than 80%; however, it depends on location and the specific characteristics of a property.
The fund may seize the title to the loan collateral in the event of default. The fund might also try to sell the underlying note to another investor or lender or restructure the loan’s terms with the borrower. The lender’s objective is to maximize the loan’s disposition value in each case while knowing the price and timing of foreclosing on the property and filing for bankruptcy. Acquiring the homes used as collateral for defaulted loans offers the best benefit. While there are many ways to increase value, some include stabilizing, enhancing, or finishing property to get the highest sale price in the shortest amount of time.