Today, the fastest and safest answer from your friendly banker is, “No.”
No, you don’t have enough equity in the deal.
No, we don’t care how long you owned the land; the entitlements you secured are not worth what they were worth last year, and other people are selling similar types of property at significant discounts to your alleged value.
No, you need a larger financial statement with a greater amount of liquidity to cover any potential cost overruns in your new project.
The lending community—from national to local banks, savings and loans to credit companies and other providers of credit—has serious concerns about today’s real estate market. Regulators are struggling with the worst credit market we’ve seen in decades amid serious questions about the soundness of the financial institutions in the United States.
How do we change a no to a yes? The answer is by understanding what the lender needs to make your transaction work. Currently, construction lenders are few and far between. Many are out of the market temporarily; some will be out longer. Construction loan transactions need to be underwritten and documented to comply with what the lender is going to need, not what the borrower wants.
We see construction lenders that are still in the market and transactions based on interest rates floating over Wall Street Journal Prime, or alternatively, interest rates floating over LIBOR (London Inter Bank Offered Rate). The margins over the index range from prime plus .50 basis points to 30 day LIBOR plus 350 basis points. This provides an interest rate for your construction loan at 5.5 percent, based on prime plus a half of one percent and 5.9 percent based on LIBOR plus 350 base points.
Underwriting the Risk
Underwriting is considerably more conservative; lenders want more skin in the game. The loan-to-value would be a maximum of 75 percent of the future value based on a stabilized project. The loan to cost would be in the range of 75 percent, which requires the developer to invest 25 percent of the total project cost in hard cash. Lenders do not take into account imputed equity in new construction financing.
The real determination in the construction lender’s opinion is when the loan matures will there be permanent loans available for this project? Or will the construction lender provide a mini-perm for a one- to three-year term? This facet of the underwriting is very subjective in the current market.