As traditional banks adjust to the new federal HVCRE banking regulations, construction financing from life insurers, pension funds and other non-banking institutional sources is on the rise, GlobeSt.com learns in this EXCLUSIVE.
SAN FRANCISCO, CA — Commercial mortgage lending continues to be healthy in 2017, with rates remaining at historic lows compared to the projected increases anticipated earlier this year, according to Robert Slatt, principal with commercial mortgage banking firm, Gantry. As traditional banks adjust to the new federal high-volatility commercial real estate/HVCRE banking regulations, construction nancing from life insurers, pension funds and other non-banking institutional sources is on the rise. These loans spread the risk of new construction for extended terms, ensuring new projects can still secure debt at the reasonable rates no longer available from traditional banks, he says.
Gantry’s correspondent lenders have placed nearly $500 million of construction to permanent loans during the past 12 months for development projects in the retail, multifamily, self storage and mixed-use asset classes. Gantry closed $726 million of commercial mortgages across 80 unique transactions in third quarter 2017. This brings the company’s overall production to more than $1.975 billion for the first nine months of 2017.
In addition to these trends to watch, Slatt recently shared banking law changes, construction to permanent loans and the climate for development financing in this exclusive.
GlobeSt.com: What changed in banking laws and how is that affecting traditional development financing?
Slatt: The HVCRE exposures guidance was placed on banks at the onset of 2015, requiring a 15%hard equity contribution for new development loans. This had a dramatic effect on developers who were using the stepped-up basis of strategic land holdings as the primary vehicle for financing developments. This created a significant equity gap, as banks were required to retain more cash on hand in front of the hard equity, requiring more cash in the deal to mitigate the exposure. This also reduced the leverage offered in these traditional loan structures to 60 to 65% loan to value instead of the traditional 70 to 80%.
GlobeSt.com: How are construction-to-permanent loans filling the emerging gaps?
Slatt: This change in banking laws has had one positive effect in that non-traditional lenders like pension and insurance companies are now offering development financing. These lenders are not regulated by the banking industry so they are not necessarily subject to HVCRE requirements. This is a new frontier for these conservative lenders and more recent phenomena. For them, this is a way to lend money and generate higher returns. For example, these lenders typically compare returns from mortgage rates with investment grade bonds to determine allocations. In these loans, they see a premium because of risk which is mitigated with the long-term structure. When an insurance or pension lender prices a loan, it locks in a permanent interest rate looking forward for a two to three-year period during development, a big plus for developers benefiting from the historically low interest rate climate in the contemporary market. The goal for developers is really to take interest rate risk out of picture with this type of long-term loan, with typical terms ranging between seven to 20 years. Multifamily has been the primary asset class leveraging this finance model, along with strategically positioned self-storage assets.
GlobeSt.com: Other product types such as office, industrial and retail require a fair amount of pre-leasing. What is the climate for development financing in general moving into 2018?
Slatt: While Congress may alter or eliminate the HVCRE rules, life insurance and pension lenders will remain more active in development financing regardless. That’s a positive. However, regardless of structure, the climate for funding new development is now cautious and conservative. Most lenders and capital sources believe we are in the latter innings of the current cycle. Two years from now, rates should be higher, but not for those who are locking in rates today with a construction to permanent forward commitment. Expect all projects emerging in the next two years will require more equity than ever before. Still, insurance and pension lenders do not have owners covenants, network and performance hurtles that are required for similar loans from banks. In the right situation, these life insurer and pension fund loans may very well become the preferred option regardless of HVCRE rules, a happy outcome of this market cycle.