Unpacking Liquidity in Private Credit
July 25, 2024
There’s a transformational shift going on real estate development financing, and it’s going to stick around. Rather than real estate developers turning to banks for financing, they’re working with private credit lenders to bridge the short-term gap between development/rehabilitation and asset stabilization (after which developers can move to traditional long-term financing, like Freddie Mac and Fannie Mae).
In the past, regional banks were the preferred financing mechanism for real estate developers. Cheaper rates and the certainty of closing were the driving forces. That has changed. The bank loan process has become cumbersome and time consuming, bank rates are closer to private market rates, banks demand borrowers leave deposits (above the FDIC insurance limit) in their institution to “qualify” for a loan, and loan applications often get rejected after months of time and effort. The private markets, with their attractive and flexible terms, lack of bureaucracy, and faster turnaround, are causing developers to ask: Why go back to the old ways when the private markets are creating a more welcoming environment? This new state of bridge financing is not only good news for developers, it’s also creating very compelling opportunities for investors seeking alternative investment options.
The shift in real estate developer expectations
For as long as anyone can remember, banks have been the mainstay of real estate bridge loans. Regional banks, in particular, were committed to supporting real estate development in their local communities. However, in the last few years, because of banks’ prolonged processes and inability to provide truly tailored financing solutions, developers have become unsatisfied with banks. The more proactive developers have turned to alternative avenues for financing. And we truly mean alternative.
We have seen this before
Early real estate movers saw that what’s happening in real estate financing mirrors the circa 2008 corporate financing crisis. Corporate bank loans and bond deals were at a standstill. Corporate borrowers that could get an investment or commercial bank’s attention spent long and oftentimes wasted hours creating elaborate pitch presentations, with no assurance of whether investors would bite. It wasn’t uncommon for them to have to revise their presentations and take it on the road again. And once a bond offering was successfully deployed, they’d have to service hundreds of bondholders.
Private credit firms said: Come work with us. We’ll figure out terms, just you and us. It will be a lot less work and a whole lot faster. And once the deal is done, we’re the only party you need to service.
One by one corporate CFOs saw the value of the private market proposition. Some may have initially hesitated because of the few basis points premium that corporate private credit charges. But, how much is executive time and energy worth? How much were these corporations spending on internal staff, lawyers, and more to get bank deals done. How valuable is certainty? Corporate private credit offered a more streamlined process. Pretty soon, there was a seismic shift with corporations abandoning bank financing and moving to private corporate credit – and staying with private credit, even after banks started to lend again.
The same phenomena is happening today in the relationship between real estate developers and private credit providers. Private credit offers faster turnaround, greater assurance, and less paperwork in both the application and servicing of the loan.
And then a recent event sealed the transition.
1H2023 changed everything for banks
The collapse of Silicon Valley Bank (SVB) in March 2023, followed by a few others, laid bare that regional banks had too much risk exposure and not enough liquidity. The sector has pulled back from lending while they get their balance sheets in order and calm their investors’ nerves. But real estate developers still need bridge financing and, once again, private credit is able to provide it.
It’s been over 18 months since SVB’s collapse and, in that time, real estate developers have come to see what corporate borrowers saw 15 years ago: private credit offers tangible benefits as a financing path and is worth the small extra cost.
Will regional banks start lending again? Yes, once their CEOs manage to create more liquidity. The same moral hazard that applies to big banks and stress tests has finally trickled down to regional banks. It will take a while. Will banks’ inherent processes change? Not likely and not enough. As corporations saw, private credit provides a fundamentally easier avenue to financing.
Real estate private credit: time and substance
For the real estate development market, 2024 is the equivalent of corporate credit’s 2009. There’s an upheaval in where borrowers are getting their financing. Similarly, as investors in 2009 found out, those that get into the market early are best positioned for higher returns. Early timing can pay greater dividends.
But what about substance? Some private credits lenders bring more experience and a more robust approach, with committed capital – but not all. Fairbridge was established in 2018 by three industry veterans with extensive experience across finance, real estate, law, loan structuring, and portfolio management. And while there may be many bridge lenders, not many are scaled bridge lenders with committed capital. Fairbridge applies an institutional approach to meeting developers’ financing needs. We have an established track record of audited financials, a seasoned credit committee, and a focus on repeat borrowers who have demonstrated a history of success.
Change happens. In the case of real estate development, the move to private credit is helping to expedite projects, And now that developers have an easier, faster and more flexible financing path to asset stabilization, they are not going back to banks. It’s a tipping point ripe with opportunity for both developers and those who invest in private credit funds.
To learn more about real estate private credit and Fairbridge’s institutional approach, reach out to us or visit fairbridgellc.com.
