Commercial Real Estate Lending: The Best Backdoor into the Finance Industry?

I’m always amazed by readers who get interested in finance and then conclude that they “need” to win front-office investment banking roles.

That hype over IB has decreased over time, but it still exists.

But if you’re at a non-target school, you’re a career changer, or you’re from a non-traditional background, you’ll often get better results by applying to client-facing roles outside of banking.

At the top of that list is real estate, and commercial real estate (CRE) lending more specifically.

Not only does it offer a path into real estate private equity, buy-side lending roles, and more, but you also don’t need a certain GPA or university name to do it.

I wanted to learn more, so I recently caught up with a reader who moved into the field from investment banking:

The Art of the Deal: Breaking into Real Estate (and Commercial Real Estate Lending)

Q: Can you walk us through your story and explain why you moved from investment banking into real estate?

A: Sure! I went to a non-target school in the Midwest of the U.S. and had no real interest in real estate back in university.

Just like everyone else, I became interested in finance over time, but my school mostly placed people in corporate finance, consulting, and accounting roles.

Through massive amounts of networking, I won an offer at a local boutique investment bank that did a combination of public finance and healthcare deals.

You can read “Healthcare” as “Rural healthcare housing for elderly people” – not exactly the most exciting market.

Since these “healthcare” deals were closely linked to properties, I kept meeting real estate lenders in the M&A deals I worked on.

And they kept pointing out how much more deal flow they had, and how they worked on more varied and interesting deals.

Plus, the compensation wasn’t much different: As you’ve pointed out before, regional boutiques tend to pay significantly lower bonuses and base salaries.

So, after just over a year on the job, I switched to a well-known CRE lending firm that works on deals across all asset classes.

Q: You mentioned that these CRE lending firms are looking for slightly different candidates than banks are.

What are the differences?

A: There isn’t one “standard profile” like you see in IB: Some people join as Analysts straight out of university, others work in real estate IB first, and others come from commercial banking or real estate development roles.

There are quite a few people from target schools, but there are also far more candidates from state schools and lesser-known universities here.

“Prestige” is less of a factor because lenders only care about your ability to get the job done.

Q: I see. With such a wide range of candidates, what do they ask about in interviews?

A: A big point of differentiation for CRE lenders is how quickly they can get deals done – investors often come to us and say, “I need this loan within 30 days. If you can’t do it, I’ll go to these three other lenders.”

So, in interviews, they test your willingness to work long hours on tight deadlines.

That’s sort of similar to what bankers are looking for, but the difference here is that you work on far more deals with more frequent deadlines.

You also have to be willing to get into granular details, such as site inspections for properties, which a lot of bankers don’t enjoy.

Real estate market analysis is a big part of the role as well, and it’s somewhat different from what you do in IB and other fields.

On the technical side, your case studies and Real Estate course give a good idea of what to expect.

Interviewers might give you a stabilized multifamily deal (i.e., core real estate) and ask, “What’s the maximum IRR we could earn on a loan for this deal? How would you structure it?”

So, you have to look at the Debt Service Coverage Ratio (DSCR) and other credit stats/ratios and back into a reasonable interest rate and other terms.

For example, if the real estate pro-forma indicates that the DSCR only drops to 1.5x even under pessimistic conditions, you might be able to increase the proposed interest rate such that the DSCR declines to 1.3x – 1.4x (or whatever the minimum is).

Lenders focus on the downside cases, so most case studies boil down to: “If things go horribly wrong, would we lose money? If so, don’t do the deal.”

The best lenders also understand the metrics and goals of equity investors, so they’ll also test your ability to calculate the equity IRR and structure the debt in order to maximize that IRR.

The Art of the Lender: Why You Might Want to Consider CRE

Q: Thanks for that summary.

What are the advantages of CRE lending roles over real estate private equity, REIT, or developer jobs?

A: You’ll get exposed to far more deals, and you’ll work across asset classes and products in every major market.

You’ll work with mom-and-pop sponsors (e.g., wealthy doctors who get into real estate) all the way up to Starwood Capital.

You’ll earn less than you would at a RE PE fund or a large bank, but the compensation is still quite good for recent university graduates.

It’s not as granular as a developer role, but it is more granular than the work at a bank, a REIT, or a RE PE fund.

Q: OK, thanks for clarifying. What are the main “deal types” in this industry?

A: We issue three main types of real estate loans:

1. New Construction Loans – Loans to fund a new development before it generates any cash flow.
2. Bridge/Temporary Loans – For when a sponsor or owner is trying to re-position an asset or otherwise improve it (e.g., for a value-added deal).
3. Permanent Loans – For acquisitions of existing, stabilized properties that are not expected to change much.

Permanent Loans are split into Senior Debt and Mezzanine.

With Senior Debt, the property acts as collateral, so we can foreclose on it and recoup some of our losses if the deal goes horribly wrong.

In most U.S.-based deals, Senior Debt lenders are willing to go up to a 75-80% Loan-to-Value (LTV) Ratio, i.e. they will lend up to $750 or $800 million for a property worth $1 billion.

Mezzanine comes in if the sponsor wants to go above that level, and it might take the LTV from 80% to 90%.

Mezzanine is unsecured, so it has higher interest rates than Senior Debt.

Even though Mezzanine in real estate doesn’t provide equity ownership, it is very close to equity because the risk profile is similar (they’re both junior to Senior Debt), and because equity IRRs are limited for stabilized properties.

Our firm doesn’t focus on Mezzanine, but we occasionally do deals there.

Q: Speaking of that, which firms participate in these markets?

A: New construction lending is dominated by commercial banks – the likes of Wells Fargo, KeyBank, and smaller regional players.

In the permanent lending space, non-banks tend to dominate: CRE lending firms, companies that do securitization, and even life insurance companies.

That happens because commercial banks face a lot of regulations on CRE lending, and they can’t issue loans with terms longer than 10-20 years.

Bridge/temporary loans are somewhere in between those two extremes.

In the U.S., Fannie Mae and Freddie Mac dominate the residential mortgage market (close to 50% market share), so most of our deals are for multifamily, office, and retail properties.

Fannie and Freddie also have a large presence in the multifamily market, and many banks and real estate finance companies have licenses to make multifamily loans on their behalf.

You can see a list of approved lenders here.

Under these programs, the licensed lenders make direct loans to borrowers and participate in risk-sharing with Fannie and Freddie. All the loans are eventually securitized as well.

This setup might sound crazy, but both firms’ multifamily portfolios performed well during the Great Recession; the single-family loan portfolios were disastrous.

About 80% of our loans are packaged into commercial mortgage-backed securities (CMBS), so they don’t stay on our Balance Sheet.

Q: And how many of these deals come from RE PE funds vs. REITs vs. other real estate investors?

A: Real estate private equity funds bring us about 40% of our deals, which is not surprising since they tend to buy properties and flip them in 4-5 years.

REITs send us about 25-30% of our deals, which makes sense since they tend to have longer holding periods than RE PE funds.

And then “other real estate investment firms/individuals” send us the remaining 30-35% of deals.

These are often independent firms that raise capital on a deal-by-deal basis (instead of the LP/GP model that PE funds use) and have much longer holding periods.

Q: Thanks for explaining that.

Let’s say that a real estate investor brings you a deal and asks your firm to provide Senior Debt at a 70% LTV Ratio.

What analysis would you complete to make a decision?

A: First, we always look at the sponsor. If it’s a first-time sponsor or it has no real estate experience, that’s a big red flag, and we’ll usually stop right there.

We also do an in-depth analysis of the sponsor’s Balance Sheet, liquidity, and contingent liabilities, and we have to understand how the deal is structured and syndicated in terms of joint ventures and the GP/LP split.

Then, we’ll look at appraisal reports on the property itself – engineering and environmental assessments, zoning reports, and more – to assess the property’s condition and anticipated repairs.

We’ll also do a market analysis to assess where the rents, Cap Rates, and vacancy rates currently are in the cycle.

This part is easy in some markets, such as San Francisco, but much harder in places like Atlanta that move up and down rapidly.

We pay the most attention to peak-to-trough rents, i.e. the highest and lowest rents over the past several cycles.

If we lose money when we assume a decline down to the trough rent, the deal is probably a “No.”

But we also look at supply and demand, how much new construction is starting, and how competitive properties are performing.

For office and retail properties, we look at the individual tenants and lease expirations and analyze the creditworthiness of those tenants.

If we see a big retail tenant that has been struggling financially (think: Macy’s), that is a big red flag even if its lease expiration is years away.

Once we finish all that, we get into the numbers and modeling work (your real estate financial modeling course is helpful for getting up to speed here).

We start by assessing the property’s value and making sure it’s reasonable; if the Cap Rates and LTVs for previous sales don’t support what the sponsor is claiming, that is a big problem.

Then, we use the historical expense and income trends to build forecasts for the next 5-10 years, including metrics like the DSCR.

We focus on the worst-case scenarios and run sensitivities around cases such as catastrophic drops in the occupancy rate (e.g., 90% to 75%) to see how bad things could get.

If we conclude that the company can still service its Debt even under those conditions, then we’ll likely approve the deal.

Finally, as I mentioned before, we also look at deals from the perspective of equity investors and calculate their potential IRRs so we can assess the best debt structure for them.

The Art of the Comeback: On the Job, Pay, and Exit Opportunities

Q: Thanks for that overview.

From what you’ve described, it sounds like the work environment is still intense and the hours are still quite bad.

A: Yes and no. It is a bit more relaxed than IB, but it’s still intense because we have to look at so many deals and get them done quickly.

The hours are similar to those in banking: 12-14 hour days, with occasional weekend work (you could argue the hours are slightly better due to less weekend work).

The main difference is that when there is downtime, you don’t have to sit here and pretend to be busy; you can just go home.

Q: And what about the compensation?

A: It’s less than what you’d earn as an IB Analyst at a large bank, but it’s on-par with regional boutique pay.

Base salaries are around $60K – $70K, and the bonus will take you closer to $100K total. The average is probably between $80K and $90K for entry-level Analysts.

Once you reach the Associate or Assistant Vice President (AVP) level, the typical compensation range is $175K – $300K, and sometimes it’s higher than that.

Bonuses are heavily linked to revenue generated, even more so than in investment banking, so the range varies a fair amount from year to year.

Keep in mind that many positions are not in New York, and so that money goes a lot further in cities like Dallas, Chicago, and Charlotte.

(NOTE: Compensation figures as of 2016/2017.)

Q: OK – that compensation is quite a bit less, which may be one reason why these roles are less popular.

What do most people in CRE lending do in the long term?

A: The main advancement/exit opportunities are:

• Specialize in Credit – You’ll advance up the ladder and keep working on debt deals. There’s a lower compensation ceiling than in equity roles, but the hours become more flexible, and the job becomes less stressful.
• Go to the Production Side – You could also become a relationship manager, work on larger accounts, and pitch our services to prospective clients. Commissions determine your compensation, and some people make well over $1 million per year in these roles.
• Real Estate Private Equity – Your main value here is that you’ll know more about debt and different banks and lenders than most real estate professionals and former bankers.
• REITs – Again, you’ll have advantages in deal structuring and working with lenders if you go here.

Q: And what are you planning to do?

A: I’m interested in moving to the production side in the long term. I like executing deals, but I’d rather work with clients and prospects to build relationships 100% of the time.

Real estate has been so hot that I’ve been seeing a lot of opportunities from recruiters – positions at REITs, RE PE firms, and other lenders.

But I’m satisfied with where I am now, and I don’t see myself leaving the industry.

Q: Is there anything else you want to add that we haven’t already discussed?

A: If you’re not at a target school and you want to work in finance, consider CRE lending.

A lot of people don’t even know about this industry, which baffles me.

It’s easier to break into than traditional investment banking, it’s a bit more relaxed, and you can work in almost any city in the country.

Compensation is lower, but it improves significantly as you move up the ladder, especially if you go to the production side.

Finally, CRE lending gives you plenty of exit opportunities, including ones such as RE PE and REITs where prior IB experience is not necessarily a requirement.

Q: Great. Thanks for your time!

A: My pleasure.

Additional Reading

You might be interested in:

• Value-Add Real Estate: What Makes It Different, and Why You Should Invest – Maybe
• How to Get into Commercial Real Estate: Side Doors, Front Doors, Steppingstones, and Career Paths
• How to Break into Commercial Mortgage-Backed Securities (CMBS) at a Bulge-Bracket Bank