The ongoing credit crunch has made it much more difficult for investors to qualify for an institutionally (bank, broker, insurance company) financed commercial mortgage loan. Underwriting standards have become significantly stricter and lending parameters have been tightened. Banks accept very few operations, and even fewer close.

 

Many good loans that should be financed are being turned down out of hand. We call this situation the “funding gap.”

 

Recently, many hedge funds and private equity companies have recognized that an opportunity exists for companies that can help fill the financing gap by offering private commercial mortgages to quality borrowers who have been foreclosed by their banks. In the last 18 months, money managers have committed hundreds of millions of dollars into the commercial real estate finance sector. They are buying distressed mortgage paper directly from distressed lenders and are very willing to underwrite new loans against commercial buildings and development projects.

 

But before commercial real estate investors seek a loan from a hedge fund or other private lender, there are a few important things to know.

 

Private commercial mortgage lenders are opportunistic investors; A hedge fund is in business to earn high returns for its investors in a timely and efficient manner. The loans they offer will be short-term (rarely more than 36 months) and will carry significantly higher interest rates and origin points than a Wall Street bank or broker would. Also, hedge funds will be very aggressive in foreclosure situations; they will take your property if you do not comply.

 

The private funds and lenders we currently work with charge 10-15% annual interest with 3-4 points. This means that borrowers can expect to pay an APR of 13% to 19%. In addition to that, borrowers are responsible for the cost of any third-party reports that may be required, such as appraisals, environmental assessments, and feasibility reports.

 

On the plus side, capital is available for these private commercial home loans and deals can be closed very quickly. Most funds prefer income-producing investor-owned commercial buildings, such as apartment complexes, office buildings, or self-storage facilities. They will typically lend up to 65% of a property’s value and underwriting is based on equity and not credit. They will lend for both purchase and refinancing, but private loans are “bridge” loans and a viable and realistic exit strategy needs to be put in place. In other words, they will need to know exactly how their money will be paid back.

 

This credit crunch has been devastating to the commercial real estate industry and the problems are not going to go away. While we all wait for the situation to improve, private lenders, including Wall Street hedge funds and private equity firms, have cash and are willing to lend it.