Local And Regional Banks Are The Fastest-Growing Lenders In CRE

Commercial real estate developers are going small when it comes to financing projects. 

Though traditional banks have become more conservative in their lending practices and underwriting after the Great Financial Crisis, there has been rapid growth in commercial bank lending following the recovery of the 2008 recession, particularly for smaller banks.

The commercial and multifamily mortgage holdings at U.S. banks have increased 37.3% to $1.8 trillion since 2012, and the rise is attributed to a push by banks to find higher-yielding investments, according to a Yardi Matrix report. 

“For a local or regional bank, real estate loans are essentially the easiest and best asset to loan against,” O’Connor Capital Partners President Joel Bayer said. “They are brick-and-mortar and easy to understand in terms of worth as opposed to loaning to a local business.”

Regional and local banks, described by Yardi as those with $10 to $100B in assets, are the fastest-growing sector of commercial banking. Commercial and multifamily mortgage portfolios increased by more than $88B in 2017, three-quarters of which came from regional and local banks. 

Many developers are now turning to these institutions when they need funding for their latest project, as the smaller banks are prioritizing real estate lending. 

Bayer, who previously was the director of a regional bank in Florida, said it is often hard for a bank to underwrite loans for small businesses because revenues are volatile, expenses often go up and there is more of a risk the business could fail. While real estate values fluctuate, they are generally more predictable and more appealing to banks.

“Compared to other types of lending, it’s a better risk profile,” Yardi Matrix Director of Research Paul Fiorilla said. “When you look at the default of commercial mortgages originated since the last recession, defaults are next to nonexistent.”

Fiorilla’s report notes the rise in small and regional bank lending in 2012, when the sector increased its commercial mortgage holdings by nearly $173B, the largest of any banking group. The next largest holding came from banks with assets ranging from $100B to $1 trillion, which saw a nearly $133B rise in commercial mortgage holdings in the same year. Commercial lending is appealing to local and regional banks, as they provide a stable risk-adjusted return.

“The difference is the national banks like Bank of America are in so many other businesses today,” Bayer said. “They’re trying to sell mutual funds, consulting and pursuing mergers and acquisitions. The running joke is they don’t like to use their own capital for loans. For local and regional banks, their main business is a real estate loan.”

With the 10-year anniversary of the collapse of Lehman Brothers fresh on the financial industry’s mind, the question remains if history will repeat itself. Nearly 500 banks closed between 2008 and 2012, but both Bayer and Fiorilla see more conservative practices in banking today acting as a safeguard against excessive lending.

A report conducted by CBRE earlier this year found that commercial real estate debt levels compared to U.S. gross domestic product in 2017 were 20.9% — 2.2% below the 2009 peak of 23.1%. This would suggest that the industry is not overleveraged, thanks largely to more cautious lending practices and the fact that more deals are being closed through debt rather than equity, the firm reported. 

“Banks not being aggressive and there is a lot more equity in deals today,” Fiorilla said. “If property values fall, banks aren't going to get hammered to the degree they were 10 years ago.”