Key Takeaways
During uncertain times like these, the news cycle is dominated by headlines designed to unsettle an emotional and fearful public – with little attempt to explain the causes and impact of the regional banking crisis. From my position, there are three critical questions about the crisis that need to be answered from a real estate perspective:
1. How will the regional bank failures impact the credit markets?
2. How will small businesses be affected by the crisis?
3. What opportunities exist for non-bank lenders?
Impact on credit markets and policy
For the last several years, accretive financing was abundant from banks eager to lend. But the current wave of global economic and societal concerns has everyone – including those writing the checks – feeling that “the music is about to stop.”
Banks of all kinds are skittish about lending right now. As the Fed implements more stringent capital and liquidity requirements for all banks, especially midsize ones, banks must turn their attention to bolstering their balance sheets and cash reserves instead of making new loans. They’ll be especially hard pressed to make loans to companies that aren’t their clients.
Ironically, the strain on the banking system – caused largely by the Fed’s aggressive rate hiking moves – may force the Fed to slow down or even pause rate hikes for a while.
We’re talking about an unprecedented 450 bps increase, at the top end of the target range for the federal funds rate, all in less than a year. “That’s a rapid boil we haven’t seen since the late 1970s and early 80s under Paul Volcker,” observed Kraus. “In the current environment, many banks are in the bind of having to pay much more to borrow and not being able to increase the yield on their booked assets at the same pace,” Kraus added.
Small to mid-market business will be hit hard
Regional banks have long served as financing partners for smaller and lower middle-market companies that rely on them for financing and capital needs across their operating businesses and real estate assets. These businesses are certainly feeling pressure in their operations, and now that pressure is spilling over into their real estate interests as it becomes more expensive for them to buy real estate with traditional mortgage debt. With banks strapped for cash and lending slowed (or paused) entirely, smaller and middle-market businesses will seek alternative forms of financing.
One of the main draws of the regional bank is the trust and relationships that are built between business owners and their financing partners. At the end of the day, while both borrower and lender seek the most lucrative terms for their transactions, these relationships feel mutually beneficial especially as these banks can service a company’s diversified financing needs across a broad spectrum of products and services. It’s unlikely that the banking powerhouses -- which are aggressively scooping up deposits from former regional banking customers-- will have much interest in continuing personal relationships with small businesses.
Sale Leasebacks: Much more than a financing concession
This is where non-bank lenders and other creative financing sources can step up. Of these, the sale leaseback (SLB) strategy is one of the most attractive tools for businesses and their sponsors to achieve their financing goals with non-dilutive capital.
If you’re a private equity firm buying a business that owns real estate, even if you don’t do an SLB, you’re typically looking to finance the real estate with debt to help boost returns. I don’t think regional banks (or similar types of lenders) will be aggressively financing the real estate component of those transactions with a mortgage -- or using the real estate as collateral to improve terms for their traditional financing package. From now on, at least for the foreseeable future, regionals will have to be much more conservative.
While some alternative financing may take shape in ways that have little long-term benefit for borrowers (and can even be detrimental), the SLB remains a fair and viable capital solution in both good and bad economic times. In other words, a SLB is not a Band-Aid solution. Those who utilize it now will not have buyer’s remorse down the road. An SLB purchaser provides personalized relationships, like regional banks used to, and can also become a long-term capital partnership for our clients’ businesses as they look to grow and expand.
Balancing supply and demand of SLB transactions
With the challenges facing the real estate financing market, I am frequently asked whether there will be an influx of SLB sellers if buyers can’t get accretive acquisition financing. In our market, activity remains strong. Buyers are still purchasing SLBs; they are just adjusting entry cap rates or rent escalators in order to factor in more challenging financing conditions at the outset. We’re also especially focused on all-cash buyers, which do not rely on asset-level financing in order to close a transaction.
We’re all rooting for regional banks and their recovery, but the show must go on. Alternative lending sources are well positioned for their time in the sun.
Conclusion
If you’ve been looking for alternative financing strategies in today’s volatile environment, please don’t hesitate to reach out. I’m happy to discuss creative options that you may not even know exist!