As a youngster on the scene of financial assets, real estate debt funding is growing into a precocious, well-loved sensation that shrewd investors are seeking for right now. Forms of debt funding have been around for a while, but the big launch for debt funding that we recognize today came after the 2008 recession, which was caused by an over-puffed banking and mortgage lending system. In 2010, the Federal administration passed the Dodd-Frank act aimed at promoting financial stability by improving accountability and transparency in the lending industry. This and other reforms at the time changed how banks and lending institutions could loan out funds. At the time of the recession, traditional commercial credit withered and banks suffered severe liquidity issues. Many private lenders, including real estate debt funds, stepped into this funding gap and began lending to commercial real estate developers and businesses. In other words, private equity investors became lenders in a field where banks and other lending institutions now had difficulty going.
Real estate debt funds help connect borrowers with short-term capital for commercial real estate projects that regulated institutions don’t want or can’t fund. Common types of debt funds include bridge loans, construction loans, redevelopment loans, plus others. Developers typically seek debt funding for projects such as multi-family housing buildings, shopping centers, medical buildings, office buildings, or senior citizen living.
Debt funding—as opposed to equity funding—has some strong advantages that would likely appeal to investors. One of the advantages is the shorter hold time, sometimes as low as a year.
Another advantage to debt funding is the lower risk versus equity funding. In this case, the loan is secured by the property. Therefore, if the borrower becomes unable to pay the loan, the fund is in first position to begin foreclosure proceedings and recoup any loss acquired.
Quarterly interest payments are more predictable in terms of amount and frequency, adding yet another advantage to debt funding.
The lower risk of debt funding has its drawbacks, mainly a cap on the return an investor can receive. The returns are limited by the interest rate, which usually doesn’t change. Therefore, the investor must decide if they are willing to forgo whatever other potential might exist for earning higher yields in exchange for a safer bet and steady, predictable quarterly payments.
Big, direct lending firms are experiencing many calls from developers and potential borrowers, but the institutions are unable to follow through. Opportunistic firms with flexible capital to lend to distressed companies at steeper discounts are being more active.
Many providers of dept funding are quite limited in their investment parameters and are unable to provide the flexibility such as Paradyme has in making loans under $10 million, for example. It’s a sweet spot where the potential borrower’s need is too large for small lenders, but too small to seek loans from large, non-bank institutions. Paradyme is funding the gap. Call us today to see how you can be a part of this exciting solution.