How construction loans are rebounding – Business Watcher
The events of the past 18 months have plunged much of the commercial real estate world into turmoil, and construction loans were no different at first. But, while some sectors have been hit harder than others, construction credit has seen a dramatic comeback.
Partner Insights spoke to Garrett Thelander, general manager of real estate finance at CIT, for a closer look at the state of construction loans today.
Business Observer: How would you characterize the state of construction credit today?
Garrett Thelander: It is very healthy. Banks, debt funds, and life insurance companies are all very active in this space. Traditionally, banks have been the most dominant lender in the construction industry. However, today life insurance companies and debt funds have created capital compartments for bridging and construction loans. There is a huge amount of capital on the lending side, there are more players in the debt space, and the acquisition volume is declining, which has resulted in much more competition in the space. construction.
Where currently is the greatest opportunity in construction loans?
Within the industrial and residential rental markets. In connection with the industrial market, we are witnessing an acceleration in demand – induced by the increase in online purchases – which is pushing the need to build distribution centers.
There has been an explosion in the number of companies needing to deliver products to consumers in less than a day, prompting the development of last mile distribution facilities. I’ve seen an increase in the number of custom racks, which is a construction loan to build, say, a million square foot warehouse specifically for an e-commerce business.
As for the residential rental market, the theft from New York seems to be a distant memory. Concessions have evaporated, rents are on the rise and tenants must commit to housing visibly. A similar dynamic is occurring in many of the larger urban areas, where there is still a demand among millennials and empty nesters to reside in a vibrant downtown. Therefore, we are seeing a strong demand for construction loans to finance residential projects in these areas.
Was the CIT previously industry driven or was this a recent change?
Before the pandemic, CIT was active in the five major asset classes: residential, office, industrial, retail and hotel. While we have not excluded office, retail and hotel loans, given the uncertainty that reigns in these sectors, CIT is focusing more on residential leasing and industrial projects. Many employees still work remotely, business and leisure travel has declined, and physical retail remains problematic.
Given recent changes in the industry, have lenders had to adjust their sales and lending strategies?
Many banks stopped lending during the pandemic and used the downtime to assess the potential risks of their real estate portfolios, as well as all of their other portfolios. Eventually, the banking market realized that the economic downturn hadn’t impacted their real estate portfolio as badly as they thought. reflect this.
Today, banks are focusing more on transactions, increasing their leverage and reducing their prices. Additionally, banks that are typically recourse lenders are exhausting their recourse much faster than ever before, as it appears they are more comfortable with the fundamentals of the real estate market remaining strong. There is a limited supply of transactions and a huge supply of capital, so the tactics have become more aggressive on the sales side.
Talk about the difference between the current state of base construction and the current state of transitional and adaptive reuse projects.
There is a lot of capital available for basic construction and transitional and adaptive reuse projects. CIT lends on both basic and value-added construction projects, but we are currently a little more involved in basic construction.
As life insurance companies and debt funds have moved very aggressively into the transitional and adaptive reuse space, we find fewer opportunities due to increased competition. With building from scratch you potentially take more risk, but after 18-24 months you have brand new products and you can also use the build phase to get through a period of uncertainty.
Talk about the nature of your current competition with debt funds.
The competition with debt funds is brutal! In the past, banks have always been viewed as the low-leverage, best-price option for borrowing. Additionally, debt funds were seen as the more leveraged and less structured option, but they were still much more expensive than bank debt.
What has happened lately is that debt funds are using leverage in the form of secured loan bonds (CLOs) and warehouse lines to lower their cost of capital. Thus, debt funds compete on deals that were previously the exclusive domain, to some extent, of banks, ie basic construction and more transitional arrangements.
Two years ago, there was maybe a 200 basis point gap between a debt fund deal and a bank deal. Now that differential can be reduced to around 50 to 75 basis points.
What is the industry’s risk appetite today and what asset classes are being exploited?
There is no asset class today that cannot get a loan. There are even many lenders in the hospitality, retail and office industries. Because the fundamentals of real estate remain strong, the risk appetite of the banking market is healthy, and it is increasing. The same goes for debt funds and life insurance companies.
An interesting trend that we are seeing today is that sponsors are withdrawing their equity from a transaction, through the debt markets, much earlier than before. Typically, a sponsor would not take capital from a project until it is 85-90% leased. Today, because the debt markets are so foamy, sponsors are now able to extract equity from a deal at substantial completion, long before a major lease has taken place. place.