Traditional Real Estate Finance Problems

Inefficient, opaque, limited access, and expensive

Traditional real estate finance can be split into two principal categories - commercial bank financing and private market lending. Given the downturn in economic performance across all asset classes, with the possible exception of industrial warehousing, commercial banks have shifted towards restructuring existing loan portfolios by deferring or suspending principal and interest payments. However, existing facilities are not increasing to keep up with current market financial pressures. And with little to no government-backed fiscal stimulus, working capital reserves have been depleted. Interest continues to accrue on existing facilities, but the ROI dynamics in the vast majority of business sectors have degraded, resulting in net negative valuations when factoring in anticipated short-term to midterm asset performance. As a result, few existing borrowers are able to demonstrate the capacity to service existing debt, making increases to current credit facilities commercially unfeasible. With an expected increase in current portfolio default, commercial banks have effectively suspended lending to new projects in favor of pushing existing clients into debt settlement agreements against depressed asset valuations. These policies, coupled with the lack of government-backed fiscal support, have created a vacuum regarding access to commercial financing.

In addition to the foregoing, commercial banks rarely extend working capital facilities, preferring instead to limit the scope of their lending activity to project and construction financing. And despite conservative loan-to-value ratios, banks will not support clients with short-term working capital facilities to cover operating costs, resulting in small creditor default risk. In essence, even real estate assets maintaining material positive equity are at risk due to short-term liquidity pressure.

Given the complexities of the traditional lending process relating to organizational inefficiencies, cross-team risk avoidance, and slow approval and deployment, traditional bank lending is limited to only those enterprises with capital reserves - debt servicing capacity that is substantially higher than that anticipated payments. As a result, commercial bank lending ends up being an exercise in project-specific capital structuring for dominant enterprises. These facilities are limited to new developments or acquisitions, meaning no capital can be allocated to the general health of the real estate asset or enterprise. The inflexibility of the lending process results in asset-rich enterprises having no access to liquidity.

Private market lending, while available, typically entails interest rates that are 100% higher than commercial bank rates, including arrangements fees and onerous default penalties. In addition, private lenders will often require ownership transfer of the asset to the lender as security, instead of the more traditional mortgage registration, and asset transfer to the lender may not be commercially feasible insofar as it may invalidate material commercial agreements. Furthermore, the borrower faces redemption risk (i.e., lender breach on repayment) and typically no option for extension of restructuring. Private lending is therefore deemed to be high risk. However, given limited access to commercial bank financing, it remains a common practice in many markets.