Banks Sneak Back Into CRE Lending Through Private Equity Firms
Where there's a buck to be made, Wall Street will find a way.
New regulation, known as Basel III Endgame, requires large financial institutions to hold significantly more capital in their reserves than before to prevent bank failures. The rules are aimed at reducing risk-taking by banks, which includes lending to real estate.
But instead of being held back, those institutions have turned to private equity to do their lending for them.
“Banks want to finance guys like me, have me do the direct lending,” Fortress Managing Director of Investments Steven Parrinello said during Bisnow's New York City State of the Market event last week. “Because that's what regulators are forcing them to do.”
Banks are already limiting their lending to real estate while they offload nonperforming loans from their books, prompting alternative lenders to fill the gap. Now, Basel III, which will be implemented starting in July 2025 with a multiyear transition period, means that the price of lending to commercial real estate is more exorbitant.
As of the third quarter, banks accounted for just 18% of loan origination, down from 38% a year earlier, according to a report by CBRE.
Alternative lenders were responsible for 34% of closed non-agency loans, up from 27% last year. Among those types of lenders, debt funds' activity skyrocketed 70% year-over-year, according to CBRE.
Historically, banks have been responsible for roughly half of all commercial real estate loans.
Private equity executives said at the event, held at 3 Times Square, that the shifting sources of originations are, in part, because of banks beginning to comply with Basel III regulation.
“The large money center banks are just under such a financial incentive to do less direct lending to borrowers and instead do more lending to us through warehouse lines, repos and things like that where they get more advantageous capital treatment,” PCCP Managing Director Brian Haber said onstage. “That's all going to drive more market share to alternative lenders.”
Big banks already had requirements surrounding reserves, but the regulation standardizes a credit-risk approach across all banks with $100B or more in assets.
On average, the amount of capital banks keep on hand will rise 16%, and the largest institutions will be required to hold another $2 in reserves for every $100 of risk-weighted assets on their books, according to a statement by Federal Reserve Vice Chair for Supervision Michael Barr.
Bank CEOs have come out in opposition to Basel III, saying the capital requirement will lower profits despite giving them more of a cushion in times of stress.
Executives claim that the regulation is detrimental to homebuyers, retirees and small business owners. And many already predicted the shift to alternative lenders.
“Real changes need to be made to address this over-calibration, or we risk a serious impact on financial institutions’ ability to raise and lend money for companies as well as assume risk on behalf of pension funds, mutual funds and other investors,” Goldman Sachs CEO David Solomon said in his December 2023 testimony before the Senate Committee on Banking, Housing and Urban Affairs. “We believe this will negatively harm the American economy without making the U.S. financial system safer.”
JPMorgan Chase CEO Jamie Dimon said Basel III is based on a false assumption that banks are under-capitalized and that the regulation wouldn't have prevented the failure of Silicon Valley Bank.
“Ironically, a proposal to mitigate risk would actually increase risk. This rule will result in an increased shift away from regulated markets to less regulated markets,” Dimon told a Senate committee last year.“This activity will be out of the sight of regulators, unable to see the next crisis brewing.”
A report by Fitch Ratings noted that the new requirements would have limited impact on banks' credit profiles, despite overall increasing the banking system’s resiliency.
Private equity firms commonly borrow from banks, especially to fund leveraged buyouts. Still, the two financial powerhouses have had a complex relationship as they've had to compete with different transparency requirements.
But the trend is now flipping the script and giving private equity firms more power.
Private equity firms have already fanned out across the real estate industry. Data centers, engineering and construction, and even parking lots have seen increased investments from firms.
“By having you go out and do the loan and then financing your loan, they've essentially created the same structure, just backwards,” Dansker Capital Group CEO Andrew Dansker said at the Bisnow event. “That’s kind of ironic.”
