Lender Tightening In the Market

Freddy Johnson
September 8, 2022

Real Estate investors seeking debt financing have heard some variation of “lenders are becoming more cautious” or “lenders are tightening” but what does that mean and can it actually be measured? The short answer is, given the economic landscape and interest rate environment, yes, lenders have pulled back on lending, however, investor demand for financing has also pulled back, creating a double whammy for debt financing and real estate transactions. With respect to measuring this pullback, we’ll dive into a few examples just to show where we are today and how that stacks up to past lending environments.

What is a Recession?

The first question is, are we heading into a recession again (if we’re not already in one), and why? The definition of a recession seems to be changing, however, the old standard measurement of a recession is two consecutive quarters of negative GDP growth. We can check that off the list as both Q1 (-1.60%) and Q2 (-0.90%) saw negative GDP growth.

The last time we saw two consecutive quarters of negative GDP growth was in Q1 and Q2 of 2020 when the COVID-19 pandemic unleashed its fury on the world and its economy. Is real estate the factor this time? No. It’s a chain of simple events. Covid hit everyone hard and locked us down. The Fed flooded the system with money and lowered rates to pump up the economy. It basically worked too well and we started having inflation. Businesses and banks were getting competitive with all of the PPPs they received and started putting more money out into the market. The relief package Biden gave families also hit the markets adding to inflation, and now inflation has started running rampant and we need to dial it back. How do we do that? The Fed started increasing the benchmark interest rate which is guidance for how banks lend to each other and ultimately the public. Most economists will tell you if you want to get this inflation thing under control you actually need to have a substantial dip in the employment rate (increase in unemployment). The Fed and the White House can’t have that, however, the Fed has said they really do want to slow down the rate of hiring which has been an inflation factor. All very odd things to hear when we’re also hearing about people not wanting to come back to work, as they have a nice benefits package for sitting on their couch and doing nothing. Strange times indeed. So, how does this affect real estate?

How Does This Affect Real Estate?

If we have a slowdown in the economy if the unemployment rate does increase, and it’s harder to afford basic staples such as bread, diapers, and utilities, then it's also going to be harder for them to afford housing, which is in huge demand and we apparently don’t have enough of it. Regardless, if there’s not enough rental revenue to support a property’s expenses and/or mortgage, real estate values will be negatively affected. Real estate investors who are consistently active in the market may shy away from making new purchases, which will decrease demand, and negatively impact valuations in the market. If we can’t put together an educated forecast of what the economy will look like in twelve months, and if we can’t predict what people can afford for housing (and other leases), then it makes it harder for us, lenders, and real estate investors to predict the future value of that real estate project they wanted to develop. Joint venture equity investors have become skittish, lenders have “tightened” up their standards, and everyone is a little nervous about what their assets, or collateral for banks, will be valued at in 2023. 

What Is “Volatility In The Debt Markets”?

When we think of volatility in the debt markets we think of disparity in lending terms. We think of the debt funds we know who have had to put the pause button on ground-up construction lending, put the pause button on all lending because their investors demand it, they’re concerned about their balance sheet, or they can’t get rid of the debt they extend to borrowers and sell on Wall Street. 

Though the “volatility in the debt markets” can be more appropriately placed to what we see on the swap desks at major banks, the volatility we see in trading treasuries, and lastly, the appetite  on Wall Street to purchase debt created from massive debt funds originating debt to build and/or acquire major commercial real developments across this great country. And what we’re seeing in the secondary markets that buy this paper, is that it’s simply slowing down and even “freezing up.” 

What Is Bank Tightening?

We have multiple factors that are causing lending tightening. First, there’s the “freeze up” mentioned above, the uncertainty around inflation, the recession, and the affordability of increased rents. For example, if a lender created a $50mm construction loan last year for John Doe’s development company, they might be reluctant to create the same type of loan for him, despite their relationship. This is in part because they can’t sell the loan they originated for John Doe or they are simply not feeling great about what the next twelve to twenty-four months will look like. 

Below is a chart put together by the St. Louis Fed that examines the “Net Percentage of Domestic Banks Tightening Standards for Commercial Real Estate Loans Secured by Multifamily Residential Structures”.  The numbers aren’t all that important, however, what is important is that the trend is upward, meaning more and more lenders are tightening their standards.  Multifamily tends to be one of the more stable (i.e. less risky) asset types, so the fact that lenders are tightening here is a sign that lenders are becoming generally more risk-averse.  The last time we saw such an increase in tightening was in 2020 (the last recession) when COVID-19 entered the scene. All are related, but different reasonings for the increase. 

Another chart to examine is how bank standards are tightening for more risky construction and land development projects.  As we can see below, this chart is also trending upwards meaning more and more banks are tightening their standards for these riskier construction and land development projects.

Is All Hope Lost for Getting Competitive Lending for Acquisitions or New Developments?

No. While we’ve seen tightening in the lending market, there are banks, credit unions, life insurance groups, and debt funds with plenty of cash. Some still have money from PPP and have been underwriting good deals. This is actually what makes the StackSource platform so useful. Since we work with over a thousand lenders across the country, we always have our eyes peeled and an ear to the ground to know which lenders are pulling back and which lenders are getting aggressive, and in which property types and markets. We have a broad reach not only across the country, but across the capital markets that leaves us in an optimal position to see increased business from that fictional John Doe developer we mentioned earlier, and add significant value to his next development. 

Find the right commercial real estate financing with StackSource by getting instantly matched to the best debt and equity options for your project from our nationwide network of capital sources. 

Our expert Capital Advisors help you secure your ideal capital stack, resulting in a lower cost of capital for your investments in less time and with more transparency than a traditional commercial mortgage brokerage. Learn more at StackSource.com.