A decade on from the global financial crisis, non-bank lenders represent an established part of the US real estate debt market. In the last cycle, non-bank lenders were part of the picture, but the retrenchment of banks from US real estate, post 2008, has led to rapid growth in private debt providers. As the market continues to evolve, five key trends are worth watching.
1. CALLS FOR REGULATION ARE GROWING
Banks remain bureaucratic and few have a lending culture attuned to the needs of entrepreneurial real estate investors. The difference between banks’ cost of capital and that of non-bank lenders representing fixed-income investors is narrowing, allowing alternative lenders to better compete with banks and gain market share. However, bank lobbyists will call for more regulation of non-bank lenders, claiming regulators need to level the playing field. For the foreseeable future though, non-bank lenders have the advantage of operating with less scrutiny, allowing them to adapt to the needs of the marketplace.
2. TRADITIONAL INSTITUTIONS ARE BUYING NON-BANKS
Morgan Stanley bought Mesa West and Goldman Sachs bought Genesis Capital. Large financial services companies, investment managers and banks will continue to purchase non-bank lenders with expertise in niche areas. Building a non-bank lending platform from the ground up is difficult for large companies. Establishing a successful formula requires a scrappy approach that is foreign to large, established financial institutions.
3. THE MIDDLE MARKET FOCUS IS INTENSIFYING
The competitive playing field for larger bridge loans is well-established. A bridge loan of $50 million in a gateway US city is likely to be offered by a dozen non-bank players, with pricing close to bank margins in many cases. However, the market for smaller loans is still dominated by local and regional lenders, with less competition resulting in higher rates. With the need to add billions of dollars of higher-yielding loans, growth-oriented lenders need to tap into the smaller-balance market – and non-bank lenders are increasingly active in this vast sub-$20 million space. Related to this, non-bank lenders will open branches in more locations and increase the ability to borrow via a variety of channels including online and smartphone applications that automate parts of the interaction between borrower and lender.
4. BORROWERS WANT FEWER LAYERS WHEN SOURCING FINANCE
Especially in the smaller-balance market, non-bank lending can involve a lot of layers; often, brokers control the relationship with borrowers. Originators underwrite and fund loans which are sometimes serviced by third parties and may be sold to funds that aggregate loans. These funds, in turn, charge a fee to the ultimate investors which may be pension funds, endowments or individual investors seeking yield. As the industry matures, borrowers are demanding better pricing and investors want the best yield possible. In a push to reduce costs, leading vendors will seek to integrate vertically.
5. SOME NON-BANKS ARE RELAXING LENDING TERMS
There are hundreds of non-bank real estate lenders in the US, many formed in recent years. To gain market share, some have relaxed lending criteria, meaning high leverage is available in niche areas of the market. The next downturn will lead to a reduction of those lenders providing high leverage to less experienced borrowers.
Jan Brzeski is managing director and chief investment officer of Arixa Capital Advisors, a private real estate lender, founded in 2006 and based in California.