Loans for the property industry are drying up fast. The CBRE Lending Momentum Index, a proxy for U.S. commercial real estate lending, fell 54% in the first quarter of 2023 compared with a year ago. Banks, which usually issue around half of all commercial real-estate loans in the U.S., are stepping back until it is clear where real-estate values will settle. Their deposits are shrinking and they need to hold on to cash in case the property loans already on their books get into difficulty.
Alternative lenders would love to fill in some of the gaps. “When the market is dislocated, it is often the best time to invest,” says Harbor Group International President Richard Litton, whose firm recently raised $1.6 billion for a debt fund focused on financing apartments.
Real estate debt funds made good returns in the years after the 2008 global financial crisis, which was the last time the banks took a step back from property lending. Blackstone said on its latest earnings call that this year will be “a very favorable time” to be a real estate lender as property owners hunt for scarce credit.
Private lenders charge a lot more than banks. Debt fund spreads for floating-rate loans can range from 3 to 7.5 percentage points above the secured overnight financing rate (SOFR) depending on the asset, according to Rachel Vinson, CBRE’s U.S. president of debt and structured finance. Bank spreads are lower—usually 2 to 2.5 percentage points above SOFR.
But the high rates that alternative lenders now charge make their loans unappealing to most borrowers. A floating rate bridge loan for a multifamily apartment block from a debt fund will cost 8% to 10% today. Property buyers would need to find buildings at a very low price to justify taking on such an expensive loan.
Debt funds charge high interest rates because they typically borrow floating-rate debt, often from big banks, to boost investment returns. Just as banks are charging landlords more, they also want a higher margin of safety with property lenders.
Alternative lenders are dealing with a slowdown in equity fundraising as well. So far in the second quarter, real estate debt funds focused on North America have raised $930 million, according to Preqin data. In the second quarter of last year, they raised over $10 billion.
Some institutional investors such as pension funds that would normally write big checks for debt funds are reducing their property bets. A drop in bond and equity prices means their allocations to real estate need to be rebalanced. That or they think better returns can be made elsewhere with less risk.
These issues might explain why alternative lenders are currently sitting on the sidelines. In the first three months of 2023, they issued fewer loans than a year ago, based on CBRE data. One area of business likely to pick up soon is mezzanine financing, as landlords are asked to add more cash to their properties to refinance loans.
The crunch in both bank and nonbank lending is happening at a bad time for landlords, as 2023 is a busy year for loan maturities. A wall of securitized debt valued at $163 billion—the biggest annual amount over the next decade—comes due this year, according to Marc McDevitt, senior managing director at CRED iQ.
This figure doesn’t include the loans sitting on banks’ books.
Alternative lenders can offer only a drop in the ocean compared with how much cash the property industry actually needs. Last month, real estate debt funds in North America had $42.7 billion of dry powder, according to Preqin data—enough to refinance just over a quarter of the securitized debt maturing in the U.S. this year.
The real solution to the property industry’s problems is to get banks lending again. It could take quite some time.