When you consider that over 80% of commercial real estate loans are held by banks, investors need to be paying attention to the current banking crisis. Here’s how the current banking crisis is impacting commercial real estate.
The American Banking Crisis
Three American banks have failed in 2023 alone. Silicon Valley Bank, which held about $200 billion in assets, Signature Bank which had assets of $100 billion, and First Republic Bank which had assets of $229 billion. All three are categorized as small to medium sized regional banks, so, why should this matter to commercial real estate investors? Well, the answer is simple: around 80% of all commercial loans in the US originate in small to medium sized regional banks. In fact, as a client of Signature Bank, this banking crisis has hit close to home. So, if you’re a commercial real estate investor you can’t risk ignoring this crisis.
4 Ways the Banking Crisis Is Affecting Commercial Real Estate Investing
I’m in the trenches every day, working on deals, managing investments, working on acquisitions, and dealing with lenders across the country. What this means is I am dealing with real time commercial real estate data from across the US, and here are four specific impacts I’m seeing in the industry right now.
#1: Traditional Lenders are Tightening Up Loan Underwriting
The first and perhaps most important impact is this: traditional lenders are changing how they evaluate a commercial real estate deal. The bank failures in 2023 and the overall environment means traditional lenders are being more cautious and becoming stricter on loan approval by tightening up their underwriting. This will impact commercial real estate investing because banks will be more cautious about risk exposure, and therefore the types of deals they’ll approve.
What that means for investors is simple: it’s time to become more creative about financing. Creative financing in commercial real estate has always been an important skill but is even more important in today’s climate. So, if you are a commercial real estate investor or are thinking about entering the fray, creative financing is a skill you must learn.
Let me give you a few examples of what I mean. Maybe you have a good deal with a motivated seller, but the property has a high vacancy. A traditional lender like a bank will see the deal as high risk. Or maybe the property has some deferred maintenance and great value-add potential, but the traditional lender denies the loan because the cash flow is low. Or what if a bank will finance the deal, but the interest rates are too high? These are all examples where creative seller financing are key.
#2: Bridge Lending is Out for Traditional Lenders
Bridge lending helps investors transition a commercial property from poor performance to a stable cash flowing asset so that it can qualify for a long-term loan. Here’s how it works: If a potential investment property is underperforming, it has low cash flow, is distressed or perhaps high vacancy, a traditional lender won’t approve a long-term loan. But the property still has huge potential, so to “bridge the gap” from underperforming to a profitable cash flowing asset, you need a bridge loan. Interest rates for bridge loans tend to be higher, but they only last for 12-18 months. The key to getting this kind of loan is having a great story, and being able to convince the lender that the property has a lot of potential and you have a plan to make it happen.
Now, in the past if you could convince the bank that your plan will work, you would get the loan, no problem. And then, after 12-18 months if the property is stabilized and cash is flowing, the bank would convert the bridge loan to a permanent long-term loan allowing you to continue to grow the value of your investment over time. Due to the banking crisis, this type of loan is done because traditional lenders are tightening up risk exposure, and underperforming deals are off the plate. Traditional lenders will see these deals as too risky, which of course, will have a real impact of commercial investors.
#3: Banks Love Multifamily Properties
As I mentioned above, I deal with lenders all over the US every week, and one thing I have learned is this: in the current lending climate lenders prefer multifamily commercial properties over all other types and here is why: first, the demand for multifamily is greater than the supply; and second, multifamily properties have stable income and value-growth potential. Confirmation that multifamily is preferred by lenders is that interest rates on an apartment building are lower than interest rates on a single-family home rental. This means that traditional lenders consider multifamily lower risk than a single-family home.
#4: Your Deal Underwriting Must Be on Point
The final impact is about you as an investor. Your deal underwriting must be wired for sound. There is no room for miscalculations on cash flow, cash return, expenses, and the overall structure of the deal. In the current climate, how you structure the deal is critical. It is the utmost importance that you get your numbers right. The margin for error is very small in the current banking climate: prices are high, interest rates are still rising, and a recession may be around the corner. In the current market there are no excuses. You need to be an expert in the commercial real estate market to make good investment decisions.
