Banks Return to Construction Lending, But Equity Shortage Stalls Deal Flow

Written by:

Rudi Davis

Date:

08 Mar 2026

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Banks re-entered the construction lending market in 2025 with compressed spreads and competitive terms. Still, developers report that a shortage of available equity, not debt, remains the main obstacle to new construction starts. Despite easier access to financing, capital remains tied up in existing projects that have not yet been sold or refinanced, preventing investors from recycling funds into new deals.

Construction lenders returned with competitive terms after a two-year pullback, but the anticipated increase in development activity has yet to materialize. Will Mitchell, Co-Founder and CEO of construction finance platform Rabbet, says the real constraint is not a lack of debt but an inability to access equity. Capital invested in earlier development cycles remains tied up in projects that have not reached sale or refinancing. That backlog is blocking new investments even as banks compete to lend.

“The thing that was holding things back and still is a large focus is just equity and getting more equity available where people have made loans or invested in deals, and they haven’t been able to transact them yet,” Mitchell says.

The equity shortage creates a paradox: while debt is readily available and attractively priced, developers cannot use it because they lack the equity needed to meet lenders’ leverage requirements. The result is a construction finance environment that appears healthy on the surface but is constrained by capital tied up in projects that cannot yet be sold or refinanced.

How Banks Returned to Construction Lending in 2025 With Better Terms but Found Few Takers

After pulling back from construction lending in 2023 and 2024 due to rising interest rates and doubts about project feasibility, banks returned to the market in 2025 with compressed spreads and more favorable terms. “Starting in 2025, we saw a lot of banks get back into construction, get very competitive at their terms,” Mitchell says. “Spreads were compressing. And where in 23 and 24 you might struggle to get anyone to give you a term sheet, people were seeing several term sheets on deals.”

During the earlier lending drought, debt funds stepped in to provide financing, but their loans carried higher costs and stricter terms than traditional bank lending. The return of bank capital in 2025 should have enabled more projects to move forward, especially for developers who had been waiting for better terms. Instead, Mitchell reports that the real bottleneck is the availability of equity.

The problem is structural, not just a result of temporary market conditions. Many equity investors who committed capital to projects between 2021 and 2023 expected to sell or refinance within two to three years. Slower sales and softer valuations have extended those exit timelines. Capital now sits in projects that are finished or nearly finished, but cannot be sold or refinanced at prices that deliver the expected returns.

Why Conservative Rent Projections Are Making New Construction Deals Impossible to Justify

Lender underwriting practices are deepening the equity shortage by forcing developers to use conservative rent projections that make new deals difficult to justify financially. Mitchell points to most banks’ refusal to underwrite rent growth during the construction and lease-up period as a key driver of the problem.

“Most banks are not willing to give trended yields on rents at this point,” Mitchell says. “You have to have untrended rents, which then it’s hard to pencil a deal today at the cost and expect in two years the rents to be the same.”

Assuming flat rents means many new projects cannot show the returns needed to justify development risk, especially compared to buying existing properties at prices below replacement cost.

“If you can buy it for less than the cost to replace it, then it’s hard to spend the money on building something and take development risk if something exists,” Mitchell says.

The replacement cost dynamic creates a feedback loop: developers are steered toward acquiring existing assets rather than building new ones. Increased competition for available properties makes it harder for developers to sell or refinance current projects. That further limits the ability to recycle equity into new development.

Why Lower Interest Rates Alone Will Not Solve the Construction Equity Shortage

While market commentary often blames high interest rates for the construction slowdown, Mitchell argues that focusing on rates alone misses the underlying equity problem. Rate changes affect both project costs and property sale values, he says, often offsetting each other.

“Lower rates lower cap rates, which then increases exit value,” Mitchell says. “So I think rates are not a big factor. Lower rates, costs go up. So it kind of works itself out.”

Mitchell’s argument challenges the common expectation that lower rates will automatically spur a broad increase in new construction. Rate policy alone cannot resolve the equity bottleneck. What is needed are better sales and refinancing opportunities for existing projects, or new equity sources willing to accept today’s market terms.

Mitchell adds that lower rates might help indirectly by reducing return expectations among equity investors, making it easier for deals to justify the numbers. “Maybe interest rates coming down would drive some higher expectations, lower expectations on ROI, better exit rates,” he says. Mitchell notes that it is difficult to single out one factor, as different deals and markets face distinct challenges.

What Needs to Happen Before Construction Activity Can Rebound

Mitchell believes that for construction activity to rebound, equity must be released from existing projects so it can be reinvested in new development. “Hopefully, they can get some cash out. They’re back optimistic and where real estate will be in a couple of years, when development will deliver,” he says.

The construction finance market is waiting for a catalyst: either improved fundamentals that allow projects to sell or refinance at acceptable values, or a reset in investor expectations that makes transactions feasible at current prices. Until one of those conditions is met, more available debt alone will not produce a meaningful increase in new construction.

Some capital is moving from debt to equity strategies to address the shortage, but the reallocation has not been enough to offset the equity still locked in existing developments. Until more projects reach sale or refinancing and investors can recycle capital at scale, the construction finance market is likely to remain constrained by the equity shortage. That constraint will persist regardless of how competitive bank lending becomes.