How you can use the power of private equity when interest rates are rising
By Eddie Chow / October 13, 2023
When interest rates go up, the knee-jerk reaction is fear and hesitation, leading to the sidelining of investment dollars. Risk-averse banks immediately tighten their credit standards at the first sign of rising interest rates and are reluctant to lend. As the FDIC states, modified interest rates can expose banks to negative shifts in the level of net interest income and impair the underlying value of their assets and liabilities. Despite all the signs pointing to a bleak situation, there is a silver lining. These are the times when investors must look to private equity as a viable alternative to counter skyrocketing interest rates.
Private equity funds are usually backed by capital from large institutional investors, pension funds, and wealthy individuals who aim to invest in situations with signs of growth potential in hopes of achieving high returns.
Banks may shy away from small and medium-sized loans as they can be less profitable, riskier, and lack sufficient collateral, while private equity welcomes these lending opportunities with open arms. These types of loans ensure that both sides benefit as real estate investors receive adequate financing and private equity firms capitalize on staking a position in the lucrative real estate market.
Private equity has several advantages over traditional lenders, especially during times of rising interest rates. Bank loans often come with rigid terms and conditions that may limit the financial goals of loan recipients. In contrast, private equity offers more flexibility when it comes to structuring financing, because each loan is unique in regard to conditions and objectives.
The hands-on approach that private equity funds take also plays a critical role in facilitating optimal results. Through their active involvement, private equity firms are better able to assess risk and manage each investment. They are also more willing to ride out temporary fluctuations in the market because of their long-term investment mindset and ability to compile customizable financing options that are not readily attainable with traditional lending institutions. In times of economic volatility, financing tailored to the individual needs of investors is highly advantageous.
As a private lender, Forbix advises clients from both the perspective of a lender and investor. We understand the importance of optimizing financing options based on each unique scenario by availing the full capital stack, including private equity, as needed. Our investment strategy is centered on one premise: value-added deals, which has been the key factor in our success over the years.
Without Forbix’s private lending services, a borrower with a newly constructed 131-unit luxury apartment in the state of Washington would not have been able to turn a profit. They needed close to $30M to pay off the existing construction lender and cover loan costs. Due to higher interest rates, the property would only cash flow for a senior debt of $22M. We arranged the senior debt lender as well as provided $6.5M in mezzanine capital and another $1M in private equity. As a result, the borrower was able to avoid default with the construction lender and successfully sell the property six months later to make a profit.
Working on deals such as this proves how valuable private equity can be in lending scenarios. We recognize the benefits of private equity partnerships and believe they are an exceptional alternative to traditional lending for real estate investors—especially in the storm of elevated interest rates.
Eddie Chow is a tenured banking and lending professional whose experience includes C-level positions with some of the most prestigious banking institutions throughout the country as well as an examiner with the FDIC.
Article from CSQ