Why California property developers are turning to private money

California property flippers and developers have been forced to find new sources of capital over the past decade.

It has been a significant yet almost silent shift in the state’s real estate dynamic.

Banks have become more selective.

But the state’s thirst for real estate development has raged unabated.

It has created one of the fastest-growing segments within private markets – real estate private credit.

Understanding this structural shift helps explain why private lending has become an increasingly strategic class asset.

Why banks are lending less

Banks have become considerably more selective in financing construction and transitional projects as a result of tighter regulations, increased capital requirements and heightened concerns over commercial real estate risk.

The changes are a direct result of the Global Financial Crisis which saw regulators introduce the Basel III framework to strengthen the resilience of the banking system.

It requires banks to hold more and higher-quality capital against riskier assets.

In addition, the failure of several US regional banks in 2023 reinforced many of these concerns.

Banks increasingly prioritize:

• lower risk

• simpler lending

• existing relationships

The issue is no more apparent than in California.

California magnifies the challenge

California is uniquely complex.

It has an ongoing and desperate need for more housing and development.

And many projects remain economically attractive.

But California developers are forced to negotiate a shopping list of complexities including:

• long entitlement timelines

• construction inflation

• insurance costs

• regulatory challenges

• housing shortages   

The solution is to source more flexible capital.

The financing gap

A financing gap has been created by the banks’ unwillingness to provide capital, even when seemingly all boxes are ticked.

A project may still fail to satisfy a bank’s lending policy despite it being:

• well located

• strongly sponsored

• demonstrating good economics

• possessing excellent collateral

Banks won’t finance these projects not because they are of poor quality but because of the tight restrictions enforced upon them.

Private lenders operate with entirely different underwriting frameworks.

Why developers choose private money

Not all development applications to banks are rejected.

But California developers are increasingly turning toward private capital because it offers features that banks cannot.

Private lending offers:

• certainty

• speed

• flexibility

• construction expertise

• relationship-based underwriting

Often, developers are prepared to pay a higher rate for these features.

The cost of capital is merely one component of a successful project.

More often, the critical factor is whether the funding will be available when it is needed and remain available throughout the life of the project.

Delays can be very costly.

Professional developers tend to evaluate debt on its overall contribution to project success, not just interest rates.

Why this matters to investors

Sophisticated real estate private credit investors are using the financing gap to their advantage.

They stand to benefit when quality collateral abounds but capital is scarce.

Private credit investors are finding consistently strong borrower demand for multiple projects such as:

• construction finance

• bridge loans

• transition lending

• acquisition funding

• refinancing solutions

The strong demand for private credit also offers investors other benefits.

Pricing power

When capital is scarce, borrowers tend to place greater value on certainty of execution, speed and flexibility and are willing to pay a premium for it. In turn, private lenders can command stronger loan covenants and conservative leverage.

Greater selectivity

With a large pool of prospective borrowers, lenders can become more selective, ensuring they favor:

• higher-quality collateral

• experienced sponsors

• conservative LTVs

• well-defined exit strategies

• strong borrower equity

Disciplined underwriting

Scarcity of capital does not mean lowering lending standards but rather reinforces the importance of disciplined underwriting.

Sophisticated lenders continue to evaluate:

• independent property evaluations

• borrower track record

• construction budgets

• liquidity and contingency reserves

• marketability of the asset

• multiple exit strategies 

California is a structural opportunity

Rather than simply filling a temporary gap, private capital is becoming an intrinsic component of California’s real estate ecosystem.

California has long-term capital requirements that only private capital can meet.

It boasts high-value collateral yet simultaneously suffers from systemic housing shortages and demand for new infrastructure, fuelled by the high concentration of its population in just a handful of its big cities.

In addition, supply restrictions exist because many developments are expensive and time-consuming to deliver, while also having to negotiate the state’s planning and entitlement complexities.

It’s a perfect storm that makes private capital the ideal source for California developers to fill the capital void.

What sophisticated investors should demand

Not every real estate private credit investor benefits equally.

Diligence is essential.

When exploring options to privately fund California developers, investors should be demanding:

• underwriting discipline with independent property evaluations

• market selection that favours high-quality collateral

• LTV policy that provides ample protection to the investor

• sponsor quality with experience and a proven track record in development

• a capital preservation philosophy that measures the success of the loan not by the highest possible yield but by consistently returning investors’ principal while generating stable, contractual income.

Put your capital to work in California real estate

The long-term opportunity in real estate private credit is not driven by interest rates alone.

It is driven by a structural mismatch between the demand for real estate finance and the inability of California developers to secure it from traditional lenders.

In California, where housing demand, regulatory complexities and capital requirements intersect, that financing gap is likely to remain an enduring feature of the market.

Central is a professionally managed mortgage fund designed to generate monthly income through short-term loans secured by California real estate.

Learn more about the fund here and set up a no obligation chat with our team.