By now we all know that the 2008 meltdown in the financial sector has had a major negative impact on the banking industry around the world. Even commercial real estate - which is usually considered less risky than residential - has suffered because banks who are fighting for their lives have been forced to change their lending policies.
For decades big banks have relied on commercial finance as one of the most profitable segments of their portfolio. The reason is pretty straighforward: larger commercial projects have been considered more reliable because lenders use more stringent evaluations of both the borrower and the risks than is the case with smaller projects.
In order to understand what is currently happening in the commercial real estate sector it is important to note the differences between commercial financing and residential financing. While they both involve an advance of funds based on the value of the properties involved, there are some significant differences in the way the risk is evaluated.
By now we all know what happened in the residential real estate market. Too many irresponsible loans were made to too many people who could not afford them. The entire system came tumbling down like a house of cards when these mortgages had to be renewed. The values of the houses had declined to less than the loan amounts, and the renewal rates were more than the borrowers could afford. So thousands and thousands of people have simply walked away from their homes.
In several ways commercial real estate loans are different. While it is true that a bank or investment company is risking more on a commercial project, commercial lending is still seen as a safer investment. The biggest difference is that the lending conditions for commercial loans are much more stringent. Commercial borrowers are typically required to provide a large amount of collateral. They must also present accountant verified asset and income statements. This allows the lender to make an informed decision on a borrower’s credit worthiness.
Large banks have dominated the commercial real estate sector because of the large amounts of money involved. But the meltdown has forced most big US banks to make serious changes. And these changes are having an interesting impact on commercial lending.
Big banks with extensive exposure to real estate markets are pruning marginal accounts in an attempt to limit their exposure. This sometimes even involves telling clients in good standing to move their accounts somewhere else. And in many cases whether a commercial deal looks good or not it will not go ahead with a large bank because they have decided not to expose themselves further to that sector.
Ironically this creates opportunities for other lenders: small banks and brokers with connections to other sources of commercial real estate capital. These smaller lenders are often willing to consider good deals that the large banks no longer find attractive.
