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Alternative Lending in Real Estate - [Business Breakdowns, EP.195]
Business Breakdowns
Deep Dive
What was the commercial real estate lending market like in 2004, and how did Madison Realty Capital start?
In 2004, the commercial real estate lending market lacked an alternative lending industry. Madison Realty Capital started as a hard money lender, focusing on quick-closing loans for time-sensitive property purchases. The firm was founded by Josh Zegen and his college roommate, Brian Schatz, who recognized the opportunity in providing senior-secured loans at a premium. They raised $350 million in their first fund and evolved into a single-source capital provider with over $21 billion in assets under management.
How did the global financial crisis impact the commercial real estate lending market?
The global financial crisis led to stricter regulations on banks, limiting their ability to provide high-value-add and construction loans. This created a gap in the market, which private credit firms like Madison Realty Capital filled. Post-crisis, banks were restricted to offering 50-60% loan-to-cost construction loans, which were insufficient for developers. Private credit firms stepped in to provide 65-75% loan-to-cost construction loans, leveraging their flexibility and lack of regulatory constraints.
What are the key dynamics of construction lending in commercial real estate?
Construction lending is highly customized, with developers needing 65-75% loan-to-cost financing to achieve returns. Post-financial crisis, banks were limited to 50-60% loan-to-cost, creating an opportunity for private lenders. Madison Realty Capital provides whole loans and partners with banks to offer higher leverage. The process involves iterative draws over a 3-4 year project, requiring strong borrower-lender relationships and experienced servicing to manage delays and issues.
How has Madison Realty Capital evolved its lending products over time?
Madison Realty Capital initially focused on higher value-add lending, including construction and renovation loans. Over time, they expanded to include transitional loans for properties post-construction, creating their Income Series in 2020. They also began providing back leverage to other private credit funds, filling the gap left by banks. This evolution allowed them to serve borrowers throughout the lifecycle of a property and offer more flexible financing options.
What role does private credit play in the current commercial real estate lending market?
Private credit has become a significant player in commercial real estate lending, especially post-financial crisis and post-COVID. It provides flexibility, speed, and certainty that banks cannot offer due to regulatory constraints. Private credit firms like Madison Realty Capital fill the gap left by banks, offering higher leverage and customized financing solutions. The private credit market has grown to include diversified asset managers, but dedicated real estate credit firms remain competitive due to their specialized expertise.
How does Madison Realty Capital manage risk in its lending portfolio?
Madison Realty Capital employs a comprehensive risk management strategy, including a full asset management team that monitors projects weekly. They review budgets, milestones, and market conditions, ensuring projects stay on track. The firm also uses external consultants to inspect properties monthly. This approach allows them to address issues early, manage extensions, and ensure loans are repaid. Their vertically integrated model, including property and construction management, further mitigates risk.
What impact did COVID-19 have on Madison Realty Capital's lending business?
COVID-19 caused a 60-90 day shock to the system, with fears of liquidity drying up. However, Madison Realty Capital had just closed a $700 million fund in February 2020, positioning them to capitalize on opportunities. They bought $200 million in performing multifamily loans during the crisis, leveraging their expertise in real estate debt and asset management. The pandemic highlighted the importance of flexibility and the ability to act quickly in volatile markets.
What are the current challenges and opportunities in the office real estate sector?
The office sector faces significant challenges, particularly with Class B and C properties, which are seeing low absorption rates. Class A properties, however, remain strong. The lack of liquidity in the office market has bogged down capital, limiting transactions. Conversion of office spaces to residential is a potential solution, but it is complex and costly. Madison Realty Capital has less than 1% exposure to office, allowing them to focus on more resilient sectors like residential and hospitality.
How do interest rates impact the commercial real estate market?
Higher interest rates benefit lenders like Madison Realty Capital, as their loans are floating rate. However, rates also impact property values and the investment sales market. The volatility of rates, particularly the 10-year Treasury, creates uncertainty for buyers and sellers. Consistency in rates within a 50 basis point band is crucial for underwriting and financing real estate deals. The current 'higher for longer' rate environment has slowed transaction activity, but a more stable rate outlook could revive the market.
What future opportunities does Madison Realty Capital see in the private credit market?
Madison Realty Capital sees significant opportunities in both direct lending to borrowers and providing back leverage to other private credit funds. The firm believes private credit will continue to fill the gap left by banks, especially in a higher interest rate environment. They are focused on creative deal origination and leveraging their expertise to navigate the current market dynamics. The firm is also exploring opportunities in non-performing loans and restructuring plays, particularly in states with quick foreclosure processes.
- Founded in 2004
- Initially focused on hard money lending
- Evolved into a single-source capital provider
- $21 billion in assets under management
Shownotes Transcript