The bridge lending space continues to become crowded and intensely competitive. In the past, bridge lenders were often overlooked or thought of as less important than larger, more traditional financing sources. But given the complexities involved in commercial real estate investments, these short-term loans are now vital components in today’s capital stack.
Funding a project today — whether it’s the development of a new office building or the acquisition of an older apartment complex — is often more complicated. It also can be riskier and more time-consuming. To reduce the risk, commercial mortgage brokers and their investor clients have increasingly turned to a wide array of capital sources to bring their vision to life.
Generally, projects are divided into different elements for a number of reasons, such as aligning them with the timing of required capital or the introduction of a specialized lending capability. These elements may be based on risk profiles or other factors. The capital stack has expanded and borrowers no longer need to rely on one funding source for the entire project from start to finish.
This year is shaping up as another active year for commercial real estate, whether it be on the lending, sales or leasing sides. In 2022, the Mortgage Bankers Association estimates that commercial and multifamily mortgage lending is expected to reach $895 billion, a slight increase from 2021.
It’s also expected to be a strong period in regard to commercial real estate bridge lending. Lenders and borrowers are seeking opportunities in the commercial real estate space, and increasing amounts of collateralized loan obligations (CLOs), which are securities composed of repackaged loans that are sold to investors, are being purchased.
Not only are bridge lenders active in the current market, but commercial mortgage-backed securities lenders, credit unions, insurance companies and banks also are back in the mix of the usual cast of lending characters. The result is more competition and a much larger amount of capital being deployed since second-quarter 2021.
An example of the elevated levels of available capital can be seen in the CLO space. In 2021, U.S. CLO issuance volume for commercial real estate reached $45 billion, more than double the $18.1 billion in issuances made in 2019. In 2020, only $8.3 billion worth of CLOs were issued, a figure clearly impacted by the COVID-19 pandemic. Tighter pricing reflects how much money is in the system as bonds are sold. Supply and demand are high as investors seek yield.
The dominant factors driving today’s commercial real estate market include optimism sparked by the post-pandemic recovery, readily available capital and pent-up consumer demand.
Mortgage brokers and borrowers should consider a number of asset classes and markets to focus on in the near term. Multifamily housing and industrial properties continue to be the darlings of the market from both lender and borrower standpoints, followed by office, retail and hospitality. There also are some excellent opportunities in the self-storage and manufactured-housing sectors.
In terms of geography, there is tremendous growth in secondary markets such as Austin, Raleigh and Orlando, to name a few. Across all property types, large urban markets have been heavily impacted during the pandemic. They are making progress but are proving slower to recover. The Sun Belt region should continue to see major population gains, benefiting states such as Arizona, New Mexico, North Carolina, South Carolina, Florida, Tennessee and Texas.
The dominant factors driving today’s commercial real estate market include optimism sparked by the post-pandemic recovery, readily available capital and pent-up consumer demand. There also is a growing demand for alternative investments such as real estate-backed debt funds, which serve as a hedge against the volatility of stocks and other investments as well as the lower rates of return offered by traditional sources.
On the capital-deployment side of the business, there is an increased appetite for bridge loans from borrowers who are having trouble getting funds from traditional lenders. Bridge lenders provide products to help sponsors finance an asset from renovation through stabilization, creating additional value and repositioning the property to a higher and possibly better use. Bridge lenders work with borrowers to structure loans, help them execute their business plan and deliver an asset with increased value.
The U.S. economic recovery accelerated quickly in the spring of 2021 as businesses reopened and investment activity gathered momentum. This time also was marked by large amounts of capital that came flowing back into the market after sitting on the sidelines.
The CLO market for securitized bridge offerings is now quite active with spreads on recent issuances at or below pre-pandemic levels. The acquisition side also is growing fast. There are opportunities to acquire and possibly rehabilitate properties at attractive levels of return given the amount of capital in the system.
Last year, many bridge lenders encountered opportunities that were primarily high-quality transactions involving stabilizations in core markets. They took advantage of the lack of capital in these markets to make higher-quality loans that they never would have won in pre-pandemic days.
Due to the higher amounts of capital infusions, these transactions are now being snapped up by other funding sources at interest rates well below those of the average bridge lender. In some ways, it’s a race to the bottom. Given the challenges for the economy, capital markets and real estate investors over the past two years, the velocity at which business has roared back into the market has been surprising.
Obviously, some commercial real estate sectors are doing better than others. While multifamily and industrial properties have fared well, the hospitality and office sectors are improving but still struggling. Central business district (CBD) properties have been hit especially hard. The CBD office sector suffered as people worked from home or from satellite offices during the past two years.
Even as employees continue coming back to the office, the pandemic has fundamentally changed this asset class. Satellite offices may offer better options for some workers rather than commuting to a centralized location. This will change the office dynamic, although it remains to be seen what the lasting impacts will be.
Watching for dangers
Despite the better days that 2022 has brought, there are potential dangers. One area to watch is the long-term impacts of the various foreclosure and eviction moratoriums, as well as rent restrictions that some states imposed over the past few years.
Although the federal eviction moratorium ended in August 2021, some states and cities enacted their own bans that lasted well beyond that date. The question yet to be answered is, what will happen when all moratoriums are lifted? Will tenants be evicted and will landlords be able to recover past-due rent? Many in the commercial mortgage industry believe it is unlikely that apartment owners will be able to recover all of their deferred rent payments. Some smaller landlords who were unable to access rent-relief funds during the pandemic were forced to sell their properties to recoup losses.
Another consideration is how the values of underlying assets that were subject to rent restrictions will be impacted over time. For example, the effects of the state of New York’s Housing Stability and Tenant Protection Act of 2019, which implemented a series of initiatives (including rent controls) are still being assessed. Market participants will be watching to see how these factors play out for property values and revenue streams. They have already translated to the lending side, especially in value-add transactions where future rents are essentially capped.
The good news is that states are relaxing restrictions and the majority of people have been vaccinated, which has greatly reduced the health threat. Businesses have reopened and the economy is rebounding. Even the hospitality sector, which many thought would take two to three years to recover, has already started to bounce back as travel and tourism have picked up.
The advice for mortgage brokers and borrowers is similar to what was offered before the pandemic. Even in unsettled times, there is so much capital in the market that borrowers have many options to get their projects financed. It is highly recommended to carefully select a lender, especially when it comes to time-sensitive projects.
It is wise to conduct due diligence on a lender, and to speak with other brokers and borrowers who have transacted with them, rather than only shopping for the provider with the lowest costs. They may not necessarily be the best lender over the long term. Surety of execution is more important than the interest rate and it is the key element for short-term deals that require a quick closing.
Make sure the lender actually has the capital required to help execute a sponsor’s business plan. What’s the point of going with a low-cost lender if they can’t ultimately fund your client’s initial loan or future commitments? Pricing isn’t everything. Service and surety of execution matter so that a borrower can execute their business plan successfully.
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Bridge lenders should always pay close attention to the pricing and structure of a loan by comparing where permanent rates are today versus where they may be in two years. One of the big considerations today is to ensure that the bridge lender can be taken out once the borrower’s business plan has been accomplished, so stress-testing loans at the start helps to determine where they will be at the end. This determines the pricing and structure on the front end, and ultimately where and how aggressively a lender can be in placing its capital. ●