Real Estate Lending on commercial projects has sunk to historically low levels, threatening a rise in loan defaults and a major decline in new construction projects. This couldn’t be happening at a worse time for the already beleaguered banking community.
Banks, insurance companies, and other lenders have been reducing their commercial loan portfolios since the beginning of 2022. There are several reasons for the slow down.
1 – Commercial Property prices have decreased substantially since the Fed began raising interest rates last year. This is becoming a lose-lose scenario for lending institutions.
Let’s say they finance a $1M deal today. Five years from now when that loan comes up for renewal, the building might only appraise at $700K forcing the borrower to cover the bank’s loan-to-value ratio with a cash call. If the borrower can’t cover, then the whole thing will just turn into another foreclosure nightmare for the bank.
2 – Commercial loans are normally tied to bonds. Banks lend money that comes in from their depositors, but they also lend based on money they borrow from the Fed.
Usually this is relatively safe because the bond markets are stable. But the recent volatility caused by the Fed raising interest rates and bond traders concerned about the future has made this practice less safe and even unprofitable in certain instances.
3 – The continuing worry of commercial loans going into foreclosure causing another real estate recession has banks holding onto every dollar possible. They need to maintain their liquidity ratios in order for the FDIC to not take over the bank and sell it to new owners who can properly capitalize the institution protecting its depositors.
These and other issues have put lenders in a position where they don’t want to take on additional risks. The last time that banks lent at levels as low as last quarter was way back in 2014. Other commercial lenders such as Real Estate Investment Trusts (REIT’s) have almost completely stopped lending as of the beginning of this year.
If you’re one of my longer-term readers, you know that I’ve been predicting a real estate recession for quite some time. This is probably just the opening salvo of a much wider slow down.
Bad loans are on the rise. PNC Bank reported that the amount of their non-performing loans doubled in the second quarter alone. Also, national data is showing that construction starts on new commercial projects will be down an average of 17% this year.
Let me leave you with this.
So where does that leave us?
If you’re one of my customers who are having difficulties getting their new projects financed, I have three pieces of advice.
1 – Bring your project to as many lenders as you can. What one lender doesn’t like may be exactly what another is seeking. Just because someone says no, doesn’t mean that you should stop trying.
2 – If you’ve exhausted all of your regular banking channels, there are always hard money lenders that charge a more exorbitant interest rate. Many times this rate is as high as 1.5% or 2% monthly. If your project is one that isn’t long term, where the profits would justify the higher interest rate, then this should be considered.
3 – If none of this works out, then put your project on hold. It will take some time, but things will go back to some sort of normalcy.
Be patient. No one wants you to go to the poor house over on a new project.
We’re all going to get through this. Let’s get through it together.
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