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Your Guide to Real Estate Debt Funds in Commercial Real Estate

Commercial Real Estate Debt Fund Guide by CommLoan

One of the most positive things to come out of or get fine-tuned from the financial crash of 2008 was the rise of what is called real estate debt funds. Real estate debt funds connect borrowers, which, more usual than naught, are developers to short-term funding capital. This funding is used for commercial real estate projects that range from shopping centers to multi-family buildings.

It was the Dodd-Frank regulatory legislation that increased liquidity requirements through much-needed changes. The liquidity requirements called Basel III impacted asset-based lending banks and other capital lending sources who had to come up with a new way to become cash flow lenders. Real estate debt funds became one of the most profitable commercial real estate lending niches that many people don’t know a lot about.

Read on to learn more about real estate debt funding and how it’s used in commercial real estate in the guide below. Debt fund financing is one of the most lucrative private equity-backed capital available that lends money to real estate buyers or owners who have real estate assets.

Commercial Real Estate Debt Fund

Real estate debt funding relies on investors that, when they use these types of fund applications, receive payments with interest charged against the loan capital. The investors also get the security charged against the property mortgage or assets. Real estate debt funding offers collateralized loans through the senior real estate assets of borrowers for almost any type of commercial or real estate project need.

Most of the time, debt funds focus its loan strategy or investment ideas on assets that range from commercial or industrial projects to vacant land for use. The three most common types of debt funds are offered through what traditional lenders won’t consider for borrowers. That’s why borrowers with more complex or layered financial situations who can’t get a conventional credit loan can use debt financing to meet their commercial real estate purchasing needs.

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Three Most Common Debt Financing Loans

The three most common types of debt financing loans offer different incentives and benefits depending on what the investor and the borrower want and need.

#1 Bridge Loans

There are times when a bridge loan may be needed by a sponsor who wants to obtain value-add to a multifamily or commercial property acquisition. Even with COVID 19 in play and many financial lenders slowing down or stopping their bridge loan services, there are financial investment companies that can find you the debt financing tool that works best for you. Bridge loans help you secure permanent financing or removes an existing financial obligation through a short term loan.

Bridge loans help you meet any current financial obligations by giving you the cash flow you need to meet your financing needs. Most bridge loans are for no more than a year and have a higher interest rate than a standard loan. They also have to be backed by some form of collateral you own or have in your range of real estate assets or inventory stockpiles.

#2 Construction Loans

Construction loans are a form of debt funding in that they are short-term loans taken out by builders or home buyers who are developing and building their own homes. They are also suitable for about one year, but borrowers sometimes refinance their construction loan by obtaining a permanent mortgage or new loan that helps them pay off their construction loan. Most of the time, borrowers have to pay interest on their construction loans if their project is ongoing and they aren’t finalized.

There are construction loans that require a borrower to pay it off completely when the project or construction is over. From the investor side, construction loans charge borrowers a minimum down payment of 20%, and some go up to about 25%. A borrower sometimes has trouble coming up with collateral for construction loans as their hard asset isn’t built yet.

To help ease an investor’s concerns, most borrowers will offer investors a very comprehensive list of construction details known as the blue book to help validate the worth and value of their project.

#3 Property Rehabilitation or Redevelopment

Property rehabilitation or redevelopment debt financing offers investors and borrowers what’s known as the sweet spot. This is the place where borrowers need too much to go to small lenders but don’t want enough to garner any interest from the large institutional lenders. That’s known to most in the financial arena industry as anything less than $100 million.

Property rehabilitation debt financing is a streamlined process where if you’re an owner or developer that lacks equity, there are financial lenders that may require a higher (Loan to Value) LTV loan than a bank. Still, they will give you the debt funds you need for financing your redevelopment project. In practice, the loan amounts range from about $5 million to about $100 million with a (Loan to Cost) ratio LTC or LTV that’s determined by where you’re located but usually not more than 80%.

Debt Investments

One has to wonder why and how investors want to become part of the debt investment equation with borrowers. Debt funding through a direct lending funding company offers three benefits investors can’t get from almost any other type of lending process. It offers investors:

  • Consistent income with a high yield every month. These high yields for investors happen even in yield-starved economies and can average about 8% on an annualized basis.
  • Direct lending debt funding offers variety in a real estate investment portfolio that is diversified and allocates part of the investment dollars and income-producing product priority to all other positions in a capital stack.
  • When there is capital over a large pool of loans that are optimizing loan performance predictability, investors have less loan risk and help mitigate their loan exposure.

An added benefit is the annualized net to investor return on debt financing is between 10% and 12%, which can beat the interest gained on some corporate bonds and equities.

Commercial Real Estate Investing

No matter how you proceed with your commercial real estate deal as a borrower or investor, you want to understand what you gain or lose. It’s vital you understand the terms that debt financing firms use to describe the costs and financing minutiae details for each deal. You will often hear the terms amortization, loan-to-value, underwriting, title, appraisal, surveys, and more.

Each of these terms represents the lenders’ process, timeline, and any other unique transactions they provide borrowers.

Every term is usually attached to a property type of borrower category. Many borrowers are often surprised at how many debt financing lenders compete for their business. Still, borrowers that target the ones that are flexible in negotiating their lending terms often give borrowers the best deal and funding options.

Lenders are in place to evaluate the risk profile of property and borrower, and the lower the risk you present, the more options you will have in debt financing for your project.

Real Estate Funds

When you’re trying to find the real estate debt financing you need for a project, you want to seek a lender that has the stellar experience and knowledge you need. That means you want to review the projects and operations they helped facilitate through their funding. You want to gauge if they’re able to move quickly within the real estate debt fund industry. There’s no doubt that by moving quickly and facilitating change when needed real estate debt funds help to serve a vital purpose in the economy.

Real estate debt financing helps provide borrowers and investors with critical tools that help the growth, success, and development of the real estate market in the U.S. 2009 saw about 28 debt funding companies launched. That number grew to 62 in 2018, and the numbers continue to rise in both the national and global debt financing industries.

Debt Fund Financing Future

Fund managers see private real estate debt fundraising and borrowing grow every year. In the first quarter of 2020, there were about 436 funds that had a net worth of over $192 billion. That’s why lenders are raising more funds than ever thought possible with lower risk profiles of properties and borrowers than they ever imagined.

The lower the risk, the better the terms. That’s why debt fund financing works so well in commercial real estate. There’s even some preliminary talk of debt fund financing being consolidated as an industry in the near future. The lending environment has been healthy in volume and opportunities.

Debt fund loans are indeed for a specific commercial real estate deal, project, or borrower. But some companies are branching out and may only be a matter of time before some of these debt financing companies start competing with banks for the conventional or traditional commercial loan. Debt funds are always an exciting and viable option for borrowers that need commercial financing. Reach out to CommLoan for the real estate debt financing you need and see the infinite value you’ve added to your future financial success.

About Author

David Luke

David Luke

David was immediately drawn to the CommLoan mission of creating a better borrower experience when joining the firm in 2015. Initially, David helped grow the lenders on the platform by 6X and worked closely with the software team to improve accuracy and efficiency within the loan fulfillment process. David has underwritten and closed more than $2 billion in transactions ranging from bridge to permanent financing across all major capital sources. He appreciates the wealth creation that real estate has to offer and has been self-managing a small portfolio of single and multifamily properties for the last 10 years. David earned a master’s degree in business from W.P. Carey School of Business at ASU and will be completing his CCIM Designation in 2021. Show More...