There’s concern in the commercial real estate market about overbuilt properties in the office and retail sectors, as well as multi-family properties that have increased vacancies and deteriorated rental rates. These issues cause the regulators a great deal of concern about the stability of the banking industry’s loan portfolio. This consequently affects the percentage of real estate assets banks will have to write off, which reduces their capital and ability to make loans.
Nationally and state chartered banks have different capital ratios they can lend against for secured real estate properties. If your bank doesn’t have the ability to lend you all the money for your property, it can participate your loan with another bank. The problem with loan participations is they essentially ask another lender to approve your transaction, which is difficult at best and impossible at worst.
Regardless of whether you seek a construction or permanent loan, ask your proposed lender if it has the ability to approve and fund your loan without participation with another lender. If it can, submit your request. If not, keep looking.
The ideal lender is a mid-size or regional bank that is familiar with your market and did not suffer extensive exposure to high-leverage construction loans or subprime mortgage lending.
Construction financing is difficult to obtain and requires equity of approximately 30 percent to 35 percent of the total project cost. Depending on the market, project cash flow, and the vacancy rates of competing projects, you may encounter a greater equity requirement for new projects.
The lenders in today's market are looking for debt-coverage ratios of at least 1.25:1. Capitalization rates, which are being dictated by the banks and life-insurance companies, are sometimes as much as 1 percent higher than similar projects that have been used in your appraisal.
The appraisal is old news. Lenders don’t care about last quarter's cap rates. They’re looking at the future and have serious concerns about property value in today's market. Lenders call this revised underwriting the “Stress Test,” at which point they use higher vacancy factors, cap rates and interest rates to determine the probability of a project being successful.
All of this goes into determining how much money you can actually borrow. The construction lender is principally concerned with how it will get its money back, and will underwrite your loan to fit its comfort level. Lenders want to know you can obtain a permanent mortgage or a mini-perm for your project when the loan comes due. In the words of one lender, “I will not make a construction loan larger than what I would write the permanent loan for any borrower.”