The costly lessons of the Great Recession continue to influence cautious bank lending policies in commercial real estate. Expanded regulation and increasing rates and fees have taken the banking sector’s conservative underwriting of real estate financing to an unprecedented level. With tight lending criteria of conventional lenders in the real estate market, investors are actively seek alternative financing, such as real estate crowdfunding, for real estate development.
Origins of Alternative Real Estate Financing
Although many alternative financial services are centuries old, the recession formed the modern and now popular concept of alternative real estate financing. A host of big banks created a ‘capital vacuum’ through their restrictive lending resulting in certain markets and project types being underserved. Due to the gaps created by these traditional lenders, alternative finance has risen to provide additional funding opportunities to underserved real estate developers.
There are some critical spectators who hold the position that the tighter regulations are needed in the real estate investment space especially after the Great Recession, and those spectators are correct. Serious alternative real estate lenders are not looking to fund loans that will increase their risk intake with little to no chances of a successful payoff. The key difference between traditional banks and alternative/private sources of funding is the way in which the loans are underwritten, the speed of the transaction, and the adaptability of the lender. Sharestates, for example, uses a 34-point risk matrix in addition to following all regulatory standards but can still fund the loan in less than half the time it will take a traditional bank. To learn more about what Sharestates considers during the underwriting process, click here.
Essential Alternative Financial Models in Commercial Real Estate
As banking lending has increasingly become more time consuming and generally less favorable to real estate developers, alternative financial services are consistently providing these developers with more efficient funding. Some of these essential funding alternatives in commercial real estate development include:
- Bridge loans. Interim loans used to fund short-term construction or note transfer;
- Mezzanine loans. Characteristically larger commercial real estate loans comprised of debt and equity financing that grant lenders the right to convert liability to an equity interest in a company in case of default;
- Hard money. Short-term loans offered by private investors that typically carry a high-interest rate and can be utilized for acquisition and construction.
Real Estate Crowdfunding – Where the Whole is Greater Than the Sum of its Parts
With a history dating back to when customers saved the Bank of England in the 1730s, and when 160,000 people raised $101,091 for the base of Statue of Liberty in 1884, crowdfunding (in the modern interpretation) is the practice of pooling small funds from numerous individuals to fund a venture. Although this form of fund aggregation occurs on different platforms, the Internet is the primary medium of crowdfunding in recent years. The user-friendly innovation of real estate crowdfunding simplifies and streamlines the qualification process for crowdfunders and real estate developers. Product innovations such as one-click closing and auto-invest are just two examples of this innovation, and the benefits of crowdfunding are clear:
- Access to capital with fewer upfront costs;
- Viable alternative to bank loans or traditional funding; and
- Sharing an idea on crowdsourcing platforms is an effective form of marketing.
Alternative Funding: Finance Industry Evolution
As conventional lender conservatism and underwriting policies intended to avoid a repeat of the recent economic downturn have restricted growth in commercial real estate, developers are more motivated to pursue progressive and alternative means of funding for project execution. More importantly, securing a funding source less reliant on traditional lending sources offers real estate developers greater opportunities and access to capital, with less associated risk.