Alternative lenders seek to step into construction lending gap

Continued uncertainty in the construction sector has opened the door for debt funds and other alternative managers to step into a void being left as banks scale back their activity. 

“We’ve been able to fill a void where banks have not participated,” Michael Lavipour, managing director of investments and credit strategies at New York-based Square Mile Capital Management, tells Real Estate Capital USA. “When banks become less likely to lend, the first thing that goes is construction, specifically large-scale construction deals – that pullback has created a gap for us.” 

In the US, banks were the second-most active lending group in Q4 2021 – and construction loans accounted for just 21 percent of total lending volume in this period, following bridge loans at 38.5 percent and permanent loans at 35 percent, according to data from CBRE. 

“Banks balance sheets are swollen,” says Lavipour. “For large transactions, when they may have planned on syndicating, they haven’t been able to syndicate post-closing so there isn’t a lot of capital availability in the bank market. For borrowers, this means having to fight for capital availability.” 

For Square Mile, there is an opportunity to step into this gap for well-capitalized, well-located projects in strong markets. The expected rent growth in these markets is expected to outpace other market fluctuations, Lavipour adds. 

“Those projects are [therefore] still viable, shovel-ready, looking for financing and can withstand some of the construction cost increases and higher interest rates,” Lavipour says. “This creates a confluence of events, both on the real estate side, the capital market side, and then also the demand or the supply of project side, where we can get in there and raise some pretty high-quality loans and make good returns.” 

Furthermore, there is not the same disconnect between players on the development side of the business that is being seen between buyers and sellers, Lavipour adds. 

Sector by sector, lender by lender 

The residential sector has been a winning asset class in terms of investor appetite and deal volume, with Q1 2022 lending volume reaching levels not seen in six years, according to a June report from S&P Global Market Intelligence. 

The research showed US banks reported $92.4 billion in multifamily residential construction loans – a 5.3 percent increase quarter over quarter and an 18.2 percent jump compared with the first quarter of 2021. This was the largest annual increase since the first quarter of 2016, when total residential construction loans grew by 18.3 percent. 

But demand for these loans continues to outpace what bank lenders can manage due to rapidly rising rates.  

“We are not going to see the same supply of transactions we saw in 2021,” Lavipour says. “It happened in the first quarter of this year when there was still bank liquidity and rates were still low, but that’s not happening right now.” 

What’s next? 

Lavipour believes the US debt markets are very different in some ways than they were during the global financial crisis. 

“Unlike the GFC, where spreads had blown out and returns were low and it was a failed capital market system, we don’t have that right now. But we do have a lack of liquidity. We do have wider interest rates that are preventing buyers and sellers transacting in a real way unless forced to do so. It is causing a capital markets gap that is resulting in a pause in investment sales activity,” he adds.