It’s no secret that commercial real estate lending has seen a significant decline recently, with lending volumes dropping 52% in the second quarter of 2023 compared to the same period last year. This drop is being driven by several factors — rising interest rates, economic uncertainty, and lender caution about the commercial real estate market. As a result, lenders are becoming much more selective about loan-to-value ratios and requiring larger down payments.
Rising Interest Rates Drive Down Lending
The Federal Reserve has been aggressively raising interest rates in 2023 to combat high inflation. The effective Federal Funds Effective Rate has climbed from near zero to 5.33% as of August 2023. This rapid rise in rates increases borrowing costs and loan payments for commercial real estate investors. As a result, fewer investors are seeking financing, and lenders are being more cautious with lending criteria.
Higher interest rates directly impact real estate investors’ ability to qualify for loans and service debt. With higher debt payments, there is an increased risk of delinquencies or defaults if property income declines or refinancing becomes more expensive. This is making lenders nervous, so they are tightening LTV requirements and lending less overall.
Economic Uncertainty Clouds Commercial Real Estate Market
Broader economic uncertainty is also contributing to the pullback in commercial real estate lending. High inflation, rising rates and fears of a potential recession are making lenders more risk-averse. Commercial real estate is seen as potentially more vulnerable in a downturn compared to other asset classes.
The war in Ukraine has added more uncertainty to the global economic outlook. Energy prices and supply chain issues could weigh on commercial real estate fundamentals like occupancy and rents. This unknown path of the economy makes lenders wary of taking on too much commercial real estate credit risk.
Lender Concerns About Overvalued Commercial Assets
Lenders have become more concerned about asset valuations in the commercial real estate market being too high relative to fundamentals. Valuations had risen significantly in 2021 and early 2022 as investors chased yield in a low‑rate environment. Now lenders see the potential for values to decline, so they don’t want to originate loans with high LTVs.
Underwriting has tightened considerably, with maximum LTVs on commercial mortgages dropping from 80-85% in recent years to 60-70% currently. Banks are focused on borrowers with strong credit profiles and requiring at least 30% equity. More property cash flow and collateral are now needed to qualify for loans.
SBA Loans Can Help Lower LTV Requirements
Fortunately, SBA loan programs can help provide financing options and reduce LTV requirements for commercial real estate investors in the current restrictive lending environment. The two main SBA loan programs are the 504 loan program for real estate and equipment and the 7(a) loan program for general small business purposes.
The 504 program allows 90% financing structured with 50% from a private lender, 40% via a CDC lender and 10% borrower equity. This high leverage is possible because the SBA guarantees 40% of the loan through debentures. The reduced lender risk enables higher LTVs.
7(a) loans feature a 75% SBA guarantee; the SBA guarantee provides protection against potential losses for the lender. 7(a) loans can also finance equipment, working capital and renovations.
Both programs give borrowers access to favorable, fixed-rate financing over long terms like 20-25 years. This helps keep debt service manageable and improves cash flow. The SBA guarantee opens doors for those who may not qualify for conventional financing.
How Bankers Can Use SBA Loans to Lower LTV
As the CEO of one of the nation’s largest Certified Development Companies (CDCs), I recommend considering SBA loans to help your commercial real estate clients who are having trouble qualifying for conventional financing in the current tight lending conditions.
Partnering with an experienced Certified Development Company like B:Side Capital can make the SBA loan process smooth and efficient for your bank. B:Side knows all the SBA guidelines and can walk you through the steps to originate a 504 or 7(a) loan.
The SBA guarantee reduces your bank’s risk exposure, allowing you to lend at higher LTVs than you could with a conventional loan. This gives your clients better access to financing so they can still purchase or improve commercial property.
In today’s uncertain economic environment, SBA loans represent a prudent way for banks to put capital to work financing commercial real estate. The SBA guarantee provides the credit enhancement for your bank to offer loans to established owners with good business prospects. This can generate interest income without taking on excessive risk.
Our team stands to answer any other questions you may have about utilizing SBA loans at your bank. Partnering on SBA lending can be a win-win, giving your bank a profitable new product line while also helping your clients achieve their commercial real estate goals with better leverage than conventional financing.
B:Side Capital, a Certified Development Company (CDC), is a trusted provider of SBA 504 loans in Utah, Colorado, Arizona and New Mexico. Our team of seasoned professionals can help bankers assess their clients’ eligibility, navigate the application process and close the loan. Moreover, we offer resources to help bankers better understand SBA 504 loan programs. Visit www.bsidecapital.org to learn more.
