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Construction Financing

Construction Financing. William Gietema Arcadia Realty Dallas, Texas. Construction Loans. Money Moves Differently Short Term Transaction Intensive Process Intensive Overhead Intensive Fee Driven Expensive / Profitable. Sources of Construction Lending. Commercial Banks

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Construction Financing

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  1. Construction Financing William Gietema Arcadia Realty Dallas, Texas

  2. Construction Loans • Money Moves Differently • Short Term • Transaction Intensive • Process Intensive • Overhead Intensive • Fee Driven • Expensive / Profitable

  3. Sources of Construction Lending • Commercial Banks • Short Term Loans match Short Term Liabilities • High Returns Present Competitive Advantages • Local Knowledge: • Real Estate Market • Construction Market • Personal Relationships with Borrowers • Syndication of Loans Between Markets

  4. Special Risks • Takeout Risk • Opportunity Cost • Risk of Loss • Commitment for Permanent Financing • Type of Commitment • Sponsorship of Commitment • Contingencies • Delivery Date • Specifications • Economic

  5. Special Risks • Start Risk • Boundary Surveys • Soil Tests • Environmental Tests • Availability of Utilities • Zoning Verification • Availability of Building Permits

  6. Special Risks • Completion Risk • Quality of Design • Quality of Budgets • Quality of Construction • Financial Strength of Contractors • Hold Back / Retainage • Contingency Budget • Quality of Contracts • Sponsorship Risk • Experience of Borrower • Financial Strength of Borrower

  7. Special Risks • Borrower Default • Right to Recover Through Foreclosure • Right to Foreclose • First Lien Priority in Title • Title Insurance • Lien Waivers • Assignment of Contracts • Assignment of Rents • Borrower Guarantees Loan

  8. Construction Loans VsLand Development Loans • Primary Difference between a Construction Loan and a Land Development Loan are the sources of repayment. • Construction Loans - Taken-Out (Wholesale) • Land Development Loans – Sold-Out (Retail) • Subdivision of Lien and Partial Release of Loan

  9. Retailing Land

  10. Land Development Loan • Construction Lender now Responsible for all Underwriting Analysis • Incremental Repayment Over Sales Period • Loan Performance Tied to Project Performance in the Market Place • Longer Term = Extended Risk Horizon • More Interest Rate Sensitive • Quality of Collateral Subject To Change

  11. Loan Underwriting • Very Conservative • Underwriting Loan to Value Based On: • Market Value • Hard/Soft Development Cost • Discounted Bulk Sale • Value of Collateral • Financial Strength of Borrower

  12. Time and Risk • Longer Term = Extended Risk Horizon • Incremental Repayment Over Sales Period • Loan Performance Tied to Project Performance in the Market Place • Quality of Collateral Subject To Change

  13. Release Price • Determines the Amount of Principal Repayment Made with Each Lot Sale. • Intended to Accelerate Loan Repayment • Shorten Risk Horizon = Reduce Risk

  14. Developer’s Risk • Value of Inventory • Anti-Cherry Picking Clause in Builder Contracts • CC&R’s Including Architectural Regulations • Cost Overruns and Completion Risk • Contract as much away as possible • Architects, Engineers, Contractors, Lenders • Have Hard Cost Contingency in Loan

  15. Developer’s Risk • Builder’s Performance • Take Down Schedule • Specific Performance Clause • High Initial Lot Deposit • Burn Down of Deposit • Onsite and Marketing Performance Clauses • Quick Remedies Through Default Clause

  16. Time and Risk • Increased Time = Increased Costs • Pass Through Incremental Costs to Builders • Have a Soft Cost Contingency in Loan • Reduce Debt Quickly • Agree to Higher Partial Release Price • Accelerated Builder Take Down • Bulk Builder Take Down • Increase Sales Velocity • Product Diversity • Small Phases

  17. Single Product

  18. Product Diversity

  19. Project Phasing and Risk

  20. The Worst Case Scenario: Lender Declares Default • What Happens Next Depends on the Guarantee the Developer Signed • Guarantee to Repay the Loan • Guarantee to Repay all Losses • Guarantee to Repay Lost Principal Amounts • Completion Guarantee • The Loan Must Give the Borrower the Rights to Cure and Extend

  21. Equity • Sweat/Earned Equity • Unrealized Value Created through the Development Process • Hard Equity • Cash or Value Which Fills the Gap Between Total Loan Amounts and Total Cost. • It has Ownership and Participates in Profits and Losses. • It Deserves High Rates of Return • It Should NEVER be Guaranteed • It Should NEVER be the Developer’s

  22. Summary • Construction and Land Development Loans • Structurally Different from Other Kinds of Loans • Process Intensive • Extremely Time Sensitive • Expensive • The Borrower Can Manage Risks • Conservative Underwriting • Product Mix and Phasing • Allocate Risk to Others • Aggressively Negotiate Guarantees, Extensions and Rights to Cure

  23. Things To Remember • You are Responsible for the Amount of Risk you Assume • You are Responsible for Managing your Risk • Negotiate Risk Away from You. • Never Use Your Own Money • Never Use Your Own Money • Never Use Your Own Money • Never Use Your Own Money

  24. Thank You Arcadia Realty Dallas, Texas

  25. Single Product

  26. Product Diversity

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