Ragsdale: Lending parameters remain tight, loan-to-value maximum is 65 percent for most, with underwriting to 25-year amortization. For loan terms of three, five and seven years, expect to have the loan “stressed” in underwriting. For example, if your loan terms are 25-year amortization with 6.75 percent interest, the underwriter will stress these figures in underwriting at 20-year amortization with 7.25 percent interest.
Banks continue to ask for deposits at times to counter “naked lending” on commercial properties. Commercial mortgage-backed security (CMBS) loans remains out of reach. Some life-insurance companies are coming back online but tend to focus on other property types. Cap rates are still trending higher.
Should operators refinance now or wait?
Adams: The old adage, “Do not put off until tomorrow what you can do today” applies to refinancing your project. If you have CMBS financing and have a loan coming due, you’d better be out there looking to replace that loan as expeditiously as possible. The lender that funded your last transaction probably doesn’t exist to fund the refinancing of your property.
The aberration we saw where the cap rates fell through the floor in 2005 and 2006 will not be repeated in the near future. Cap rates today are increasing across the board as investors demand a greater return for taking a real estate risk with their investments.
Hill: First, take the emotion out of the process, because in this environment it’s all business. Start early. Loans take much longer to execute these days. Make sure your expectations are realistic and be prepared before you go to the lending markets with the transaction. Work hard to make sure you have premeditated the weaknesses in the deal and mitigated those up front.
If you get a proposal in hand that works with a lender you can trust, execute the transaction. Do not get greedy. Certainty of execution is paramount, and trying to gamble on an unknown entity under the allure of a more aggressive deal, or to save a few basis points in interest rate, is simply not worth the risk.
Remember, we’re in a capital-constrained environment with many deals chasing the limited dollars available, and it all boils down to your basic beauty contest. Make sure you pull out all the stops to look as good as possible before the big show. If this is not something you feel you can accomplish by yourself, hire a qualified professional to assist you—it will save you time, money and, most likely, frustration in the long run.
Ragsdale: Start early, be flexible and realistic. Understand how cap rates are impacting your values. Focus on the bottom line. Every dollar of net operating income is keenly important now more than ever.
What’s your advice for people seeking money for new development?
Adams: New construction is at a virtual standstill in most markets. The only new-development financing available in the near future will be for projects that have excellent economics, which will be created by strong capital contributions from experienced operators with strong balance sheets.
While it’s not a federal banking requirement to have a feasibility study, smart lenders will require a more in-depth analysis of your project. Remember, the real estate lending debacle has not just been subprime home loan borrowers, but commercial real estate development providing more capacity than the market was capable of absorbing.
Hill: There’s always an exception, but for the most part, there’s no debt available for new construction at this time. Lenders are busy finding solutions for the problems that already exist on their books and, therefore, maintain a risk-adverse mindset toward anything with the potential to create new problems. Construction loans by nature are speculative and more risky than refinance transactions, which have cash flow in place to service debt and an existing track record of loan performance.
If you’re looking for new development-type returns but are having trouble finding a construction loan for a new project, consider shifting gears and looking for a distressed development deal that already exists. Under this scenario, you may be able to motivate the lender by acting in concert with them. You’ll assume some level of existing (likely modified) debt that’s already in place and contribute new equity to help “right size” the deal, creating an opportunity for yourself and helping the lender solve a problem at the same time.
Ragsdale: Build a relationship with a local bank that has done construction deals in your area. Be prepared to send large on-demand deposits to the bank in exchange for development funds. Third-party reports on feasibility must show a high degree of demand for your project. Also, be prepared with a high net-worth partner on your deal who’s willing to personally guarantee the loan.