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CRE Insights Blog

Last updated on Oct 30, 2023

7 min read

by Jeff Hamann

The Role of Regional Banks in Commercial Real Estate Financing

Given the intense scrutiny some regional banks have fallen under, let's examine their role in providing commercial property loans.

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In the complex and multifaceted world of commercial real estate (CRE), regional banks have always played a crucial role. These financial institutions, deeply rooted in their respective locales, have been significant contributors to the development and growth of commercial real estate across the country.

This article examines the role of these regional banks in the CRE sector, explains why they have been the preferred choice for financing, and explores some of the unique advantages they bring to the table.

The Role of Regional Banks in Commercial Real Estate

The financial landscape of commercial real estate is vast and diverse, with funding sources ranging from private investors to large national banks. However, regional banks have carved a niche for themselves in this sector, providing a significant proportion of loans to developers and managers.

According to Goldman Sachs, around 80% of all bank loans for commercial properties come from regional banks. These banks, due to their size and regional focus, are often able to offer more personalized services, understand local markets better, and build long-term relationships with developers and property managers.

Why Regional Banks Dominate Commercial Real Estate Financing

There are several reasons why regional banks have come to play such a large role in financing commercial real estate.

Localized Expertise

Their localized knowledge and understanding of specific markets allows them to make more informed lending decisions. They possess a deep familiarity with the local economy, real estate trends, and the specific needs of property developers and managers within their region.

Note that this isn't universally true, as many regional banks lend well outside their region — take Bank OZK's involvement in Manhattan construction in the past few years, for example — but for many other institutions it's a key differentiator.

Relationship Focused

Secondly, regional banks are often more relationship driven compared to larger, national banks. They typically place a higher value on personal relationships, providing a level of service that is often more personalized and responsive. This results in a deeper understanding of the client's needs and greater flexibility in tailoring loan products to fit those needs.

Niche Focused

Regional banks also often exhibit expertise in specific types of commercial real estate that are prevalent in their areas.

For example, a regional bank in a metropolitan area with a booming tech industry might specialize in financing office buildings, while a bank in an area with a strong medical industry might have deep expertise in financing life science facilities.

The Impact of Banking Stress on Commercial Real Estate Financing

Banking stress, a term referring to situations when banks face significant financial strain, can have profound effects on commercial real estate financing, particularly when regional banks are affected.

Given their dominant role in the sector, any significant stress on regional banks can quickly ripple through the commercial real estate market, influencing lending rates, credit availability, and ultimately the feasibility of new projects and transactions. The impact of such banking stress extends beyond the real estate sector, even destabilizing the broader economy.

Consequences of Liquidity Pressures

Liquidity pressures in banking refer to situations when banks lack enough cash or easily convertible assets to meet their immediate obligations. Such pressures can make it challenging for banks to lend, as they need to focus on maintaining their own financial stability. For regional banks, which significantly contribute to commercial real estate financing, the effects of liquidity pressures can be particularly troubling.

The direct impact of liquidity pressures is a reduction in available credit for commercial real estate developers and managers. As banks focus on their own financial health, they may pull back on commercial real estate commitments, leading to a decrease in available loans for properties1. This pullback can lead to a slowdown in new commercial real estate projects, affecting both the supply and demand dynamics of the property market.

The Move Towards Tighter Lending Standards

In response to banking stress and liquidity pressures, regional banks are increasingly moving towards tighter lending standards. This means they are becoming more conservative in their lending practices, often requiring higher credit scores, larger down payments, or more stringent loan-to-value ratios from borrowers.

Tighter lending standards can make it more difficult for commercial real estate developers and managers to access loans, particularly if they don't meet the stricter requirements. It can slow down the pace of commercial real estate development, as developers may find it harder to secure financing for new projects or to refinance existing loans. This can also lead to a widening gap between buyers and sellers in the commercial real estate market, with sellers expecting higher prices based on pre-stress conditions and buyers offering lower prices due to the increased difficulty in securing loans1.

Furthermore, tighter lending standards can exacerbate the effects of banking stress on the broader economy. As the availability of credit decreases, economic activity can slow more broadly. This could, in the end, lead to a recession. The recent predictions of an impending recession and ongoing banking stress underscore the importance of monitoring these trends in regional banks and their impact on commercial real estate financing.

Navigating an Evolving Financial Landscape

Developers, managers, and investors must adapt to the evolving landscape of commercial real estate financing. It's crucial to be proactive, anticipate changes, and strategize accordingly to maintain operational efficiency and profitability.

3 Ways to Adapt

Diversify Funding Sources

Depending solely on regional banks for financing can be risky, especially given the current banking stress. Diversifying funding sources can mitigate this risk. Consider different types of financial institutions, private lenders, and alternative financing options.

Strengthen Financials

A strong financial profile can enhance creditworthiness and make it easier to secure loans. Regularly review and improve financial statements, maintain a robust cash reserve, and manage debts efficiently.

Understand Market Dynamics

Stay updated with market trends and regulatory changes. This can help in making informed decisions, predicting potential challenges, and identifying opportunities.

Alternatives to Traditional Financing

As regional banks tighten lending standards, alternative financing options are becoming more relevant for commercial real estate developers and managers.

Private Lenders

They can provide loans that are typically more flexible and quicker to process than traditional bank loans, albeit often at a higher interest rate.

Crowdfunding

This involves raising small amounts of money from a large number of people, typically via the internet. It's a viable option for smaller projects or startups, but the amount you can raise may be unpredictable.

Real Estate Investment Trusts (REITs)

These are companies that own, operate, or finance income-producing real estate. They can provide a source of financing for developers and also offer investment opportunities.

Seller Financing

This involves the property seller providing a loan to the buyer as part of the property sale. It can be a viable option when traditional financing is hard to secure.

Wrapping Things Up

In conclusion, the role of regional banks in the commercial real estate sector is changing due to the current banking stress and the resulting tighter lending standards. This is impacting the commercial real estate industry by making financing more challenging to secure.

Developers, managers, and investors need to adapt to this changing landscape by exploring alternative financing options and diversifying their funding sources. The ongoing evolution of the commercial real estate financing landscape will continue to shape the sector in the near future. This will require flexibility, innovation, and resilience from everyone involved in your investment.

Looking to stay ahead of the curve with your financing options? Fill in the form below; we'll get you quotes from a wide range of institutions — from regional banks to life insurance companies and more — that ensure you have the best loan option for your property.