The ongoing credit crisis has made it much more difficult for investors to qualify for an institutionally funded (bank, broker, insurance company) commercial mortgage loan. Underwriting standards have become significantly tougher and loan parameters have tightened. Very few deals are being accepted by the banks, and even fewer are actually closing.
Many good loans that should receive financing are being rejected out-of-hand. We call this situation the “funding gap.”
Recently many hedge funds and private equity companies have recognized that opportunity exists for firms that can help fill the funding gap by offering private commercial mortgages to quality borrowers who have been shut out by their banks. Over the last 18 months money managers have committed hundreds of millions of dollars to the commercial real estate finance sector. They are buying distressed mortgage paper directly from troubled lenders and they are very willing to write new loans against commercial buildings and development projects.
But before commercial real estate investors seek a loan from a hedge fund or other private lender there are some important things they should know.
Private commercial mortgage lenders are opportunistic investors; a hedge fund is in business to earn high returns for its investors in a timely and efficient manner. The loans they offer will be short term in nature (rarely more than 36 months) and will carry significantly higher interest rates and origination points than a bank or Wall Street broker would. Further, hedge funds will be very aggressive in foreclosure situations; they will take your property if you fail to perform.
Funds and private lenders that we work with are currently charging 10%-15% annual interest with 3-4 points. This means that borrowers can expect to pay a 13%-19% APR. On top of that, borrowers are responsible for the cost of any third party reports that may be required such as appraisals, environmental assessments and feasibility reports.
On the positive side, there is capital available for these private commercial mortgage loans and deals can be closed very quickly. Most funds prefer income producing, investor owned commercial buildings like apartment complexes, office buildings or self storage facilities. They will generally lend up-to 65% of a properties value and underwriting is equity based not credit driven. They will lend for both purchase and refinance, but private loans are “bridge” loans and a viable, realistic exit strategy needs to be in-place. In-other-words they will need to know exactly how they are going to be paid back.
This credit squeeze has been devastating to the commercial real estate industry and the problems are not going away. As we all wait for the situation to improve private lenders, including Wall Street hedge funds and private equity firms, have cash and are willing to lend it.