Board Topic: Construction Loans
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Construction Loans

Posted by: MarkM Sep 4 2004, 12:24 PM
I am in the process of forming an LLC with a general contractor and a couple of other investors. My background is in stock market finance so I am new to the concepts of real estate financing.

We would like to buy an existing property (e.g. oceanfront hotel/motel) and refurbish into condominiums. We have capital to finance 20 - 30% of the project costs (land acquisition, construction and associated soft costs). However, we do not have anyone at this juncture who could guarantee the entire project costs ($3 to $5 million).

In this scenario, what are the chances of us receiving debt financing to cover up to 75% of our project costs? We can raise equity capital to finance the entire project, but this would require giving away an unpalatable amount of our equity in the business.

Will banks or other financing institutions provide us with debt capital purely on the strength of the project without collateral and a guarantor that cover the entire project cost?

Posted by: globalhelpdesk Sep 4 2004, 12:53 PM
Edit: Financial Professionals need to register and contact information should be in the signature.

Please read the rules.

Thanks for your understanding.

Posted by: loanuniverse Sep 4 2004, 01:43 PM

When banks approach a construction request, they make use of a couple of pieces of information.

The first one is the “sources and uses of funds”, which is pretty much the budget for the construction and other costs. The uses of funds is usually divided into three categories:

land costs: Includes the acquisition and other land associated expenses such as tearing down existing construction and filling the land up to grade.

hard costs: The actual construction costs

soft costs: Other expenses such as interest and marketing.

Saying that the way a construction loan is structured means that there is no collateral, would be wrong. In fact, most construction loans are setup in a way that the land costs have to be covered with equity contributions. The subsequent draws are monitored by a construction inspector, which means that the money being advanced is being put in the ground in the form of improvements. The lender also benefits from having the general contractor bonded. This means that if the contractor fails to perform, the bonding company will complete the construction.

The second one is the appraisal”, which will give an estimate of the “as is” value as well as the “completed” value. A good commercial appraisal will even give an absorption estimate, which indicates the number of units being sold.

That is the reason why lenders require that the loans are subject to a satisfactory appraisal, that the general contractor is bonded, that draws are monitored by an independent inspector, and that is why they put limits on the maximum loan-to-value and loan-to-cost for a project.

Regarding your question” Will banks or other financing institutions provide us with debt capital purely on the strength of the project without collateral and a guarantor that cover the entire project cost?”

The answer is most bank lenders will need to get comfortable with the parties involved in the project, specially the GC. The collateral has to be there, and chances are they will not let any of the principals off the guarantee hook unless they own a small portion of the project and are completely passive in nature.

Non-bank lenders might be more lenient, but they will still underwrite this the same way.

Good luck

P.S: I just reread your post and realized that this being a condo conversion deal, that the purchase of the property will be the biggest ticket. How do you get such a broad range on project cost? I mean, the range should not be that big for condo conversion since the building is already there.

Posted by: Guest Sep 5 2004, 12:39 PM
Thanks for the quick and thorough response. The reason for the broad price range is that we are looking at a number of potential projects, but haven't yet selected one as we assessing the financial merits of each and performing the due diligence.

I guess I am still wondering whether the guarantor has to have a net worth in excess of the entire project, or if they will look at credit and the ability of the pricipals to pay back the loan over time. As it stands, none of our partners has a net worth that would cover a $5 million project. If our guarantor needs to have that sort of financial standing, then we will need to find a high net worth individual to step up on our behalf, if that is the case.

As things stand, our GC has 13 years of experience and has been voted 'contractor of the year' in his region in the past. We will also have the Director of Construction of a major international company who will sign on as a consultant on any project we will do. The remaining partners are finance professionals, including myself. I'm guessing though, based on what I am hearing, that since we have no operating history and no track record of success, the bank will look to collateralize the entire amount of the loan against a guarantor.

Posted by: loanuniverse Sep 5 2004, 02:34 PM
” I am still wondering whether the guarantor has to have a net worth in excess of the entire project”

This is not necessary, but it helps.

” the bank will look to collateralize the entire amount of the loan against a guarantor.”

The bank is already securing the loan with a first mortgage lien on the property and I can assure you that at no moment in time will the bank advance more than XX% loan-to-value and loan-to-cost against the project.

In essence the combined tangible net worth of all the guarantors will be looked at. Having a very strong personal guarantor helps, but it is not a must have. The most important criteria are:

1- Well priced units in an area with demand that will sell within a reasonable amount of time. {primary source of repayment}

2- Good “as is” and “as completed” loan-to-value. {liquidation of collateral is secondary source of repayment}

3- Experienced GC and principals.

4- Strong financial condition of guarantors. {recourse to guarantors is also a secondary source of repayment}

If you have the top three, and number 4 is not horrible there is a good chance of success at getting credit.

Posted by: shizah Sep 7 2004, 06:28 PM

There are other options that you can look at. You can try Hard Money, Private money, Joint Venture, or Equity participation. I would be interested in taking a look at the project. If interested you can PM me.



Posted by: avatarfi Sep 9 2004, 05:30 PM
I agree with Shizah, although bank financing could be difficult, you could get a hard money loan (bridge loan) that would take you through the renovation period, at which point your deal would be much more attractive to banks and you could refinance at their rates (which are much lower).

For a bridge loan, you typically pay between 10 and 15% interest as well as points, whereas a bank would be 5-9%. It's a big difference, but the bridge loan could make the deal possible...

Posted by: loanuniverse Sep 10 2004, 05:36 PM
"...although bank financing could be difficult...."

I don't think it will be that difficult. I see 30% equity, and experience from the point of view of the actual construction. My employer would probably not do it because of the lack of actual "developer" experience, but other banks might.

Of course, a lot depend on the specifics. Do not give up on the mainstream lenders until you have to, the difference in rates on a loan this size can pay for my house.

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