Presented By: CIT Group Inc.
How Construction Lending Is Bouncing Back
Future Of CRE Banking brought to you by CIT
The events of the last 18 months threw much of the commercial real estate world into turmoil, and construction lending was no different at first. But, while some sectors were hit harder than others, construction lending has seen a considerable comeback.
Partner Insights spoke with Garrett Thelander, managing director of real estate finance at CIT, for a deeper look at the state of construction lending today.
Commercial Observer: How would you characterize the state of construction lending today?
Garrett Thelander: It’s very healthy. Banks, debt funds, and life companies are all very active in that space. Traditionally banks were the more dominant lender in the construction space. However, today, both life companies and debt funds have created buckets of capital for both transitional and construction lending. There is a tremendous amount of capital on the lending side, there are more players in the debt space and acquisition volume is down, which has resulted in significantly more competition in the construction space.
Where is the greatest opportunity now in construction lending?
Within the industrial and residential rental markets. In connection with the industrial market, we have seen accelerated demand — prompted by the increase of online purchasing — which is driving the need for the construction of distribution centers.
There has been an explosion in companies that need to deliver products to consumers in less than a day, which is prompting the development of last-mile distribution facilities. I have seen an increase in the number of built-to-suits, which is a construction loan to build, for example, a million-square-foot warehouse specifically for an e-commerce company.
As for the residential rental market, the flight from New York City seems like a distant memory. Concessions have evaporated, rents are going up again, and renters are having to commit to units sight unseen. A similar dynamic is occurring among many of the larger urban areas, where there is still a demand among millennials and empty nesters to reside in a vibrant downtown core area. Therefore, we are seeing a lot of demand for construction loans to finance residential projects in these areas.
Was CIT focused on industrial previously, or was this a recent shift?
Prior to the pandemic, CIT was active in all five major asset classes: residential, office, industrial, retail, and hotel. While we haven’t ruled out office, retail and hotel loans, given the uncertainty in those sectors, CIT is more focused on residential rentals and industrial projects. Many employees are still working remotely, business and leisure travel has decreased, and brick-and-mortar retail remains challenged.
Given the recent changes in the industry, did lenders need to adapt their sales and lending strategies?
A lot of banks stopped lending during the pandemic, and they used the downtime to evaluate the potential risks in their real estate portfolios, along with all their other portfolios. Eventually, the bank market realized that the economic downturn didn’t impact their real estate portfolio quite as hard as they thought it was going to, so the banks returned to the market with a vengeance around the start of this year, and their lending tactics are reflective of that.
Today, banks are leaning more into transactions — increasing their leverage and reducing their pricing. Also, banks that are typically recourse lenders are burning off their recourse a lot quicker than they used to, because it seems they’re more comfortable that the fundamentals of the real estate market remain sound. There’s a limited supply of transactions and a tremendous supply of capital, so tactics have become more aggressive on the sales side.
Talk about the difference between the current state of ground-up construction and the current state of transitional and adaptive reuse projects.
There is plenty of capital available for both ground-up construction and transitional and adaptive reuse projects. CIT lends on both ground-up construction and value-add projects, but we’re a little more involved with ground-up construction right now.
Because life companies and debt funds have moved very aggressively into the transitional and adaptive reuse space, we are finding less opportunity because of the increased competition. With ground-up construction, you are potentially taking more risk, but after 18 to 24 months, you have brand new products and you can also use the construction phase to build through a period of uncertainty.
Talk about the nature of your current competition versus debt funds.
The competition with debt funds is brutal! In the past, the banks have always been viewed as the lower-leverage, better-priced debt option. In addition, debt funds were viewed as the higher-leverage and less-structured option, but they were always a lot more expensive than bank debt.
What has happened lately is that the debt funds are using leverage in the form of collateralized loan obligations (CLOs) and warehouse lines to reduce their cost of capital. So, debt funds are competing on deals that used to be the exclusive domain, to some extent, of the banks — i.e., ground-up construction and more transitional deals.
Two years ago, there might have been a 200-basis-point differential between a debt fund deal and a bank deal. Now, that differential can be down to around 50 to 75 basis points.
What is the industry’s risk appetite today, and what asset classes are being leveraged?
There’s no asset class today that can’t get a loan. There are even plenty of lenders in the hotel, retail and office sectors. Because real-estate fundamentals remain sound, the bank market’s appetite for risk is healthy, and it’s increasing. The same can be said for debt funds and life companies.
One interesting trend we are seeing today is that sponsors are taking their equity out of a transaction, via the debt markets, a lot sooner than they used to. Typically, a sponsor wouldn’t take out equity from a project until it was 85 to 90 percent leased. Today, because the debt markets are so frothy, sponsors are now able to extract equity out of a deal at substantial completion, well before significant leasing has occurred.
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