‘Shadow Lenders’ Step in Fill Financing Gap for Commercial Loans
Sep 23rd, 2016 @ 12:37 PM by Amber Nelson
As traditional banks face stricter federal regulation, non-traditional lenders have moved onto the scene to finance the needs of commercial real estate developers.
After the financial crisis that began almost a decade ago, the federal government instituted tighter rules on banks, requiring things like higher cash reserves and more stringent lending standards for construction loans.
There are plenty of commercial real estate developers, however, who cannot meet those credit standards and there are plenty of loans that banks find too risky to make. Investment firms have stepped in to fill that funding void, earning the name ‘shadow lenders’ as they can avoid the regulatory scrutiny that banks face. These private investment funds – including buyout firms, hedge funds and real estate investment trusts – are collectively buying up $32 billion in commercial property debt this year, up nearly 40 percent from a year ago. While they usually charge higher interest rates than banks they are also willing to take on loans that banks do not want.
However, traditional banks will lend money to the investment firms who then turn around and lend money to the commercial real estate developers. According to the Office of the Comptroller of Currency (OCC), regulated banks increased their lending to non-depository financial companies by almost 23 percent, or $41.2 billion in the fourth quarter from the previous year.
The Federal Reserve has been warning of a potential commercial real estate loan crash, as prices have roughly doubled in the past six years. Yet investment funds have disregarded those prophecies even as big banks have pulled bank on commercial lending. Investment funds make their own rules about how much reserve cash to have on hand and how much risk they take on. And as long as banks continue to feel the reigns of federal regulation, those investment firms are likely to keep on buying up more commercial real estate debt.
Amber Nelson is a seasoned mortgage industry writer and a regular contributor to Loan.com and Mortgage101.com.