The ongoing credit crisis has made it much more difficult for investors to qualify for an institutionally financed (bank, broker, insurance company) commercial mortgage loan. Underwriting standards have become significantly stricter and lending parameters have been tightened. Banks accept very few operations, and even fewer are closed.
Many good loans that should be financed are being rejected out of hand. We call this situation the “funding gap.”
Recently, many hedge funds and private equity companies have recognized that an opportunity exists for businesses that can help fill the funding gap by offering private commercial mortgages to quality borrowers who have been locked out by their banks. In the last 18 months, money managers have committed hundreds of millions of dollars to the commercial real estate finance industry. They are buying distressed mortgage paper directly from troubled lenders and are very willing to underwrite new loans against commercial buildings and development projects.
But before commercial real estate investors look for a loan from a hedge fund or other private lender, there are some important things to know.
Private commercial mortgage lenders are opportunistic investors; A hedge fund is in business to earn high returns for its investors in a timely and efficient manner. The loans they offer will be short-term (rarely more than 36 months) and will have significantly higher interest rates and origination points than a Wall Street bank or broker would. Also, hedge funds will be very aggressive in foreclosure situations; they will take your property if you do not comply.
The private funds and lenders we currently work with charge an annual interest of 10% to 15% with 3 or 4 points. This means that borrowers can expect to pay an APR of 13% to 19%. In addition to that, borrowers are responsible for the cost of any third party reports that may be required, such as appraisals, environmental assessments, and feasibility reports.
On the plus side, there is capital available for these private commercial mortgage loans and deals can be closed very quickly. Most funds prefer investor-owned commercial buildings that produce income, such as apartment complexes, office buildings, or self-storage facilities. They will typically lend up to 65% of a property’s value and underwriting is based on principal and not credit. They will lend for both purchase and refinance, but private loans are “bridge” loans and a viable and realistic exit strategy needs to be put in place. In other words, they will need to know exactly how the money will be paid back to them.
This credit crunch has been devastating to the commercial real estate industry and the problems are not going to go away. While we all hope things get better, private lenders, including Wall Street hedge funds and private equity firms, have cash and are willing to lend it.