Changing Commercial Real Estate Lending Trends
By now we all know that the 2008 meltdown in the financial sector has had a major negative impact on the banking industry around the world. Even commercial real estate - which is usually considered less risky than residential - has suffered because banks who are fighting for their lives have been forced to change their lending policies.
Traditionally big banks have relied on commercial real estate as one of the most lucrative segments of their portfolio. That is because larger commercial projects have been seen as more reliable because lenders use more stringent evaluations of both the borrower and the risks than is the case with smaller projects.
To understand what is currently happening in the commercial real estate sector it is important to note the differences between commercial financing and residential financing. Both involve a loan secured by the value of the properties involved, but there are important differences in the way risk is calculated in both cases.
What happened to residential real estate is no secret. Too many irresponsible loans were made to too many people who could not afford them. The entire system came tumbling down like a house of cards when these mortgages had to be renewed. The values of the houses had declined to less than the loan amounts, and the renewal rates were more than the borrowers could afford. So thousands and thousands of people have simply walked away from their homes.
In several ways commercial real estate loans are different. While it is true that a lender is risking more on a commercial project, commercial lending is still seen as a safer investment. The biggest difference is that the criteria for commercial loans are much more stringent. Commercial borrowers are usually required to provide a large amount of their own capital. They must also present accountant verified asset and income statements. This allows the lender to make an informed decision on a borrower’s credit worthiness.
Because commercial projects involve larger sums of money, in most cases smaller institutions had a difficult time competing with large banks. But the meltdown has forced most big US banks to make serious changes. And these changes are having an interesting impact on commercial lending.
Big banks with extensive exposure to real estate markets are pruning marginal accounts in an attempt to limit their exposure. This at times even involves telling clients in good standing to move their accounts somewhere else. And in many cases whether a commercial deal looks good or not it will not go ahead with a large bank because they have decided not to expose themselves further to that sector.
As one might expect this creates opportunities for other lenders: small banks and brokers with connections to other sources of commercial real estate capital. These smaller lenders are often willing to consider good deals that the large banks no longer find attractive.
