Why Non-Bank Lending Has Become the New Normal for Commercial Property Developers

A non-bank facility. A few years ago that wording on a development deal would have signalled something had gone wrong: a bank had said no, or a project had run into trouble and needed a rescue lender. That’s no longer how developers think about it. Non-bank lending has become a standard line item in capital stacks for commercial property developers, and the shift isn’t temporary. It’s the result of structural changes in how banks are regulated and how institutional capital wants to be deployed, and both of those forces are still building.

The banks didn’t just get cautious, they got structurally constrained

The changes began after the Hayne Royal Commission. The major banks faced pressure to alter credit standards, and real estate development lending suffered the most. New loans became harder to pay off, loan-to-cost ceilings declined, and credit committees began applying general policy settings instead of assessing the merit of each deal separately.

These changes would have not been as harmful had they been an isolated incident. But they weren’t. Banks in Australia must also follow the capital adequacy and loan growth standards set by the Australian Prudential Regulation Authority (APRA). By holding a much higher risk than a mortgage book, a concentration of construction lending leads to an increased risk for the bank. Once the board and regulators had a reason to formalize a tighter financing strategy after the royal commission, there was no turning back to the construction funding of the pre-2019 era. The non-bank funding model is not a weakness, but a different funding model.

Different funding, different underwriting

Banks have to use standardized criteria when lending since they have to manage liquidity and credit risk for a vast and diversified loan book, which is difficult to do if each borrower is considered individually. This makes them use criteria like serviceability ratios, income verification, and conservative loan-to-value settings, which can be applied across thousands of borrowers with minimal individual assessment.

Non-bank lenders, on the other hand, are funded by institutional capital with a mandate that already accepts development risk; this capital is specifically raised to be deployed into private credit and non-bank lenders do not have to manage the same liquidity risk as a bank. Non-bank lenders can, therefore, underwrite deal by deal rather than policy by policy.

And non-bank credit teams will, therefore, look at feasibility analysis first: project margin, build cost certainty, the strength of the builder, the exit pathway. A developer’s personal serviceability still matters, but it’s not the dominant test. This is the underwriting difference that actually changes outcomes for developers, more than pricing or speed.

What that means in numbers

This shows up in the loan documentation. Developer guarantees, liquidity requirements or restrictions on distributions are rarely deal-breakers for a bank. They’re more often used as a balance sheet management tool for the bank to ensure there’s enough equity in the deal even as the LVR ratchets up during construction. Banks also have a bias towards hedging, which can be expensive to establish even where scarce margin dictates it’s necessary.

Non-bank lenders don’t have the same incentives to restrict a developer’s operational freedom or require unnecessary hedges beyond what their or the investors’ risk appetite naturally requires. They’re usually focused on managing the default risk in the weakest parts of a development (like ensuring a completed property can always be sold in a distress situation for at least as much as it cost to build) or by assigning good risk (like creating a new trust to ring-fence other assets from a troubled project). Non-banks don’t particularly want to own a portion of your next townhouse project; they’d rather make a return on debt and get repaid.

Speed is an advantage that’s easy to underrate

While pricing is usually the focus of lender/finance type conversations, speed is critical. In crunch time, I can get a term sheet from a lot of non-banks by tomorrow. They may not be able to be as competitive as the banks on price, but a term sheet in my hands on Friday can make it look like they are. The banks? Not so much. They’re focused on the compliance box-ticking procedure and won’t even give me a term sheet until the boxes are ticked. In the case of a non-bank, it can be a little hit and miss. Sometimes you really don’t expect them to even come close to the bank, and sometimes they do. Point being, you can always find that out in 1-2 days.

Not just a bridge, not just a rescue

The traditional narrative that non-banks are the lenders of last resort is an outdated perspective on a sector that’s matured dramatically post-GFC. The reality is non-bank finance is now a key component of the capital stack in many property projects from the get-go. Developers know they can access land and construction loans more quickly, and typically more flexibly and for a longer term, from these continually-changing range of participants.

Mezzanine financing is used more often, and in more complex ways, since the Banking Royal Commission. Previously, some banks retiring from certain types of commercial real estate finance replaced mezzanine loans with stretched senior debt, adding layers of complexity in higher gearing scenarios. Non-bank senior lenders don’t have an issue with that layered approach to risk (or return) – that’s more about bank credit policy issues than the nature of a mezzanine loan.

The trade-off is price, and it needs a clear exit

There’s no such thing as a free lunch in non-bank lending. The interest rates and fees outside the traditional banks are above bank-senior for a reason. Firstly, risk-based pricing: the more solid the project, the cleaner the feasibility, the more credible the builder the sharper the terms. It’s not a flat premium, but it’s still a premium. Secondly, capital is more expensive. Banks currently lend real estate money at around 4.5 – 5 per cent, within an owner-occupier mid-tier margin. If you’re borrowing with a non-bank, their cost of capital is between 7 – 8 per cent, within a mid-tier mezzanine type of margin.

The truth is the loan is going to cost more than you think, so the single most important part of structuring a non-bank facility is the exit strategy. A developer needs a defined pathway before drawing the first dollar: settlement of pre-sold contracts, a refinance to bank debt once the asset is stabilised and serviceability becomes assessable again, or stage capital release, capitalised and treated as an expense within the project.

What to actually check before signing with a non-bank lender

Not all non-bank lenders are cut from the same cloth, and the difference between good and ho-hum becomes apparent when you’re at the pointy end of the construction phase requiring funds to flow exactly according to your financing plan. A few indicators reveal which lenders deliver as promised mid-project and which leave a developer exposed to loss of earnings delays and overruns that can lose the whole project.

#1: Are they proving it in the construction cycle, not just in approval rates?

Drawdown history is the best measure of a lender’s actual fitness for purpose – not the fact they’ve issued terms to X projects currently under construction. A specialized lender, particularly, should be able to point to multiple successful drawdowns against term with projects going on at any given time. Sticking with the same example, it’s one thing for a provider of Development finance Sydney to understand and believe in that city’s planning constraints and typical project length, it’s another to prove it by continuing to fund drawdowns right through mines and farming busts, when other non-bank providers pull back because they backed the wrong deals.

Real estate lending is specialty finance. Partners who don’t get out in a downturn and can keep up when the market turns are too easy to find at the top of a boom and impossible to get hold of at the bottom of a cycle.

#2: Facility Tenure – Whose interest is the lender working in?

How long is that facility term? A longer tenure typically gives you more options and certainly drops your risk of a position where the biggest debt redraw of your life is done under pressure. Two years after the facility’s paid out the last cent, the lender can still call for the last cent back under non-recourse if your project tips into default. Ideally, three or even four years from final draw, if one year into the project everything’s going well, you want the default event not to be applicable!

#3: Do they really know what they’re doing?

Planning on multiple bank or JV participants at completion? Unless you’re taking the cheap money here, your provider should be able to match or better the time lines any other party’s giving you currently. This is particularly relevant when you take the “cheap money”‘s time lines and wonder why they’ve taken a couple of hundred grand of legal fees longer to get their term right!

This isn’t a cyclical blip

It might seem like these trends are a reaction to some regulatory dynamics that will eventually blow over. But that’s not the case. Evidence from the IMF’s Global Financial Stability Report back in April 2024 indicated that the global private credit market had reached approximately US$2.1 trillion in assets under management, which is nearly double of what the amount was in 2018. This growth has been largely fueled by sovereign wealth funds, pension funds, and global asset managers making active decisions to allocate to private credit as an asset class.

This source of long-term, slightly-yielding capital doesn’t dry up after one regulatory phase. If bank interest in development lending does let up slightly at some stage in the future, the evergreen capital base funding non-bank lenders will still be in place. And the permanent infrastructure – dedicated funds, warehouse facilities, origination teams – will continue to be determined to deploy across the loan class. This means that capital will continue to flow across economic cycles, for the long term, not just this one.

For developers, the take-home message is this: non-bank lending is not a response to partway through the credit cycle, when banks are cautious and developers still need capital. It’s part of the ongoing funding mix for commercial development, and you need to build it into your business-as-usual capital planning, along with bank debt and equity.