Over the past few years, the commercial real estate market in the US has soared. There’s a rising demand for newer properties, both Commercial and residential, in most cities. This increase in demand has also led to a rise in the costs of making such investments.
For instance, the increase in construction material costs, the rise in interest rates on commercial real estate loans, and the ever-increasing property values have all rendered it harder to earn good returns on commercial real estate property investing.
With cutthroat competition in almost every field related to commercial real estate investing, it’s harder than ever to sustain an excellent revenue-generating system.
The solution? Real estate investors and companies are now looking at other ways of revenue generation from commercial real estate investing beyond investing in the equity itself. One such widely accepted method is Commercial real estate debt financing. This has been around for a while and appears to stay in the market for years to come.
What is Commercial Real Estate Debt Financing? And how does it benefit commercial real estate investors? Read on to find out answers to all these questions and understand if you want to enter commercial real estate debt financing.
What is Commercial Real Estate Debt Financing?
Commercial Real Estate Debt Financing refers to the process of providing funding to a commercial property where investors become the lenders to property owners or real estate developers.
Such loans provided by investors to owners or people who own equity in the property are secured by the property. What’s in it for investors to provide financing? Investors earn income by the interest rates of the loan amount and try to make a steady income through loan rates alone.
The idea is to change the income-generating perspective from owning the property to earning through interest rates generated from providing a loan to the property owners who own the property. How it benefits commercial real estate investors? Or, should you explore commercial real estate debt financing? Find answers to these questions in the last section of this blog.
How did Commercial Real Estate Debt Financing start?
After The Great Recession, banks became somewhat skeptical about lending loans to Commercial real estate investors. There was an increasing need for commercial spaces and investors wanted to grab that.
They can kick start their commercial real estate investing success – by acquiring more properties, flipping properties, buying an old building and transforming it into a Commercial Property, renting out Commercial spaces and so on.
However, during recession banks and other traditional lending institutions are not very encouraging about this as they were stepping back from lending money to property investors by making lending requirements more stringent by the day. That was when investors kicked into the picture.
These investors had made money from real estate investing in the past and saw an opportunity of generating money through a new income stream altogether. They start lending out loans to property owners who wish to acquire a property and earning interest income by way of lending to them. It was perfect and relevant.
That’s briefly how Commercial Real Estate Debt Financing could’ve been started although one cannot track down exactly how this kicked in.
How has Commercial Real Estate Debt Financing evolved?
After The Great Recession, debt financing became very hard, and most banks withdrew from lending loans for the purchase of commercial real estate property. It was during this time that private commercial real estate hard money lenders and private investors came into the picture, making real estate debt financing possible even after the recession.
However, not all banks withdrew from lending, and different banks had various types of loan programs, varying in plans and thus, Real Estate Debt Financing was not entirely out of the picture for banks.
The increasing number of immigrants and a rise in employment rates paved the way for increased scope in Commercial real estate industry. In relation to this, the commercial lending activity increased too. The lower interest rates and foreigners’ growing appetite for US property led to further increased activity in commercial real estate debt financing.
During the time, housing and apartment property saw a considerable growth too, and the attributable reason to this was undoubtedly the intense renter demands that were present at the moment. Even today, the multi-family property investing is very lucrative if one knows and understand their ways around it.
The next significant milestone of Commercial Real Estate Debt Financing Evolution was the rise in alternative lenders. Non-bank or alternative lenders are no longer left behind in the real estate financing game.
They cover a large portion of the market, individually and collectively and fill a void that’s left by the banks and other traditional lending institutions like insurance companies.
They’ve also become a boon to the entry-level real estate investors who do not have a excellent credit history but want to begin investing in real estate. And where banks and insurance companies act more conservative on specific types of loans, the alternative lenders come into the picture and fulfill the real estate financing needs of realtors.
Further, the present milestone of commercial real estate debt financing evolution is the increased and “still-increasing” competition between traditional bank lenders and alternative lenders.
Whilst both types of lenders have their pros and cons, what’s interesting is that alternative lenders have now come to the spotlight-grabbing away a considerable portion of market share for themselves by offering various types of loans, providing higher Loan-To-Value ratios than their traditional counterparts.
Banks and other traditional lending institutions, on the other hand, lure their customers with lower interest rates, making loan liabilities less burdensome for the investors.
However, the downside with banks is the lower LTV ratios that they’re willing to cover – averaging to about 60%. This means that investors have to bring in 40% of the property value on their own, making their immediate out-of-pocket expenses higher.
So, unless you have good savings or reserves under your name for your rescue, bank loans might not work out for the best. Alternative or private money lenders, on the other hand, can lend you a majority of the property value, having an LTV of around 80%, making your immediate out-of-pocket expenses much lesser.
However, the loan rates are usually higher than that of banks when you lend from a private money lender. So, depending on your needs and preferences, you can choose the better of the two to meet your real estate financing needs.
This is briefly how Commercial Real Estate Debt Financing has evolved from the time market boomed to the 2008 Housing Market Crash and to present date. Read on to know about how Commercial Real Estate Debt Financing works and how it benefits Commercial real estate investors.
How does Commercial Real Estate Debt Financing work?
For investors, Commercial real estate debt financing is about lending money to property owners or developers by securing the loan with a property. Such investors earn fixed rates regularly based on the loan rates and the loan amount. The returns from such investments can be very lucrative, depending upon the risk factor each investor is willing to take.
For example, Low-risk investments like stable class A property can give decent but constant returns to the investors while high-risk investments like construction projects may provide higher returns on opportunistic strategies!
Thus, Commercial real estate debt financing can work fantastic for investors with capital who do not wish to hold long term investments like equity investments and are looking for shorter-term investments with constant returns, lasting somewhere from eight months to twelve months.
How does Commercial Real Estate Debt Financing Benefit Commercial real estate investors?
Commercial real estate investors can be benefitted by debt financing through streamlining their revenue streams in terms of interests earned through a portfolio of properties secured by their loans.
The best part about commercial real estate debt financing is the security that it brings into the picture – regardless of whether the property appreciates or not, as an investor you’re still entitled to the interests, and thus your cash flow will not be affected by the changing property values.
Besides, if you’re an investor who does not want to hold-and-wait until a property has a good resale value but would instead feel happy with steady income earnings every month, then Commercial real estate debt financing is for you. It helps you earn a stable income right from month one and increases over time, as you grow your portfolio.
You can also diversify your investments in terms of risks you want to take and if you’re able to work out a plan that’s a perfect mix of high risk and low-risk investments and bring about a balance, you can rest assured about your real estate returns that is stable enough to provide you a sense of security while also being in a place to leverage on the high risk investments that offer higher yields.
