The rise of private credit in real estate is often described as banks pulling back from direct lending while non-bank lenders step in. Andy Klein, managing partner at Lionheart Strategic Management, says this narrative misses the real story: banks are still providing the capital through new structures designed to optimize regulatory treatment.
Rather than reducing exposure to real estate risk, banks have shifted how they participate in these deals. “It’s just wrapped up differently,” Klein explains. Where banks once provided senior debt directly secured by a mortgage, they now lend against loans made by private credit providers. The bank’s risk remains tied to the underlying real estate, but the legal structure of that exposure, including how it is treated for regulatory and accounting purposes, has changed.
This distinction matters for understanding the true flow of capital in today’s market and how sustainable that flow may be if regulations change.
Banks Still Power Private Credit
In the previous model, banks issued loans directly to real estate borrowers, with the mortgage serving as collateral. Today, a private credit firm like Lionheart provides the full loan to the borrower, then leverages that position by borrowing from a bank against the loan as collateral.
Now, instead of the property itself, the bank’s security interest is the private lender’s loan. Klein describes it as “borrowing against the borrowing,” capturing the spread between the bank’s lending rate and the higher rate charged to the end borrower. The underlying economics, including who provides the capital and who takes the risk, remain largely unchanged.
This structure creates an arbitrage opportunity for private credit providers. They can borrow from banks at lower rates, lend at higher rates, and keep the difference. The bank’s exposure to real estate risk is nearly identical to the old model, but the regulatory and accounting treatment is more favorable to the bank.
Regulation Fuels Structural Change
Klein points to regulatory capital requirements as the main reason for this structural shift. Banks must hold more capital against direct real estate loans than against loans secured by other financial assets. By lending to private credit providers rather than directly to property owners, banks can reduce their reserve requirements and deploy more capital overall.
“There’s different capital treatment and different reserve requirements that banks have to have,” Klein says. “It’s kind of the same exposure, but better capital treatment and less reserves required to be held, and therefore they can go make more loans.”
This regulatory arbitrage benefits both banks and private lenders. Banks make more efficient use of their balance sheets, and private credit funds gain access to leverage, which boosts returns. For borrowers, more capital is available, often with fewer hurdles than traditional bank loans.
The key fact remains: capital still comes from banks, and banks remain exposed to real estate credit risk, just through an extra layer in the structure.
Private Credit Growth Is Fragile
Klein’s analysis raises questions about how sustainable this private credit expansion is. If growth is driven mainly by regulatory arbitrage rather than a genuine capital shortage, changes to regulatory policy could quickly reverse the trend.
Klein does not expect immediate regulatory changes under the current administration but acknowledges that policy shifts could alter the economics of this structure. If regulators decide to treat these leveraged loans more like direct real estate loans, the current system could unwind quickly. In that case, capital would likely flow back into traditional bank lending structures at different price points.
For borrowers and market participants, today’s abundance of private credit may not last if regulatory incentives change. Capital still comes from banks, and their willingness to participate depends on rules that could shift under new policies or administrations.
Competition Compresses Construction Lending Spreads
This structure has also changed the competitive landscape, especially in construction lending. Klein notes that competition has increased at the senior end of the capital stack, driven by new entrants using the same bank-leverage models.
“We’ve definitely seen increased competition, and we’ve seen spreads compressed, certainly at the most senior dollars,” Klein says. As more lenders enter the market and capital becomes more available, pricing grows more competitive.
Klein says his firm maintains discipline by sourcing about two-thirds of its deals through direct relationships rather than open brokered processes. Still, Klein acknowledges that some recent deals have been “pretty tight” on pricing, reflecting a market driven more by capital supply than by underlying real estate fundamentals.
Risk Stays With the Banks
This leveraged structure is now standard across much of the industry. Banks receive more favorable capital treatment, private credit providers gain leverage and higher returns, and borrowers access capital that might not be available through traditional channels.
This is not a fundamental shift in who provides or bears the risk of real estate lending. The bank remains the ultimate source of capital and risk, now one step removed. Private credit has not replaced banks; it has created a more efficient conduit for banks to lend within current regulatory constraints.
If the rules change or banks find better returns in direct lending, the structure could unwind quickly. Capital would still be available, but the channels and pricing could shift overnight.
Regulation Determines What’s Next
For now, the system works for all parties. Banks optimize their regulatory position, private credit funds enhance returns, and borrowers enjoy more options. The entire framework depends on regulatory policy, not a true change in market fundamentals or capital sources.
The current dominance of private credit in real estate lending is more fragile than it appears. If regulatory incentives shift, capital could revert to older models as quickly as it migrated to new ones. For borrowers, today’s environment of ample private credit is contingent on policies that could change with the next regulatory cycle.
This reality is important for anyone participating in real estate finance today. The abundance of private credit is not a permanent feature but a product of evolving and potentially reversible regulatory choices.
