The Subprime mortgage mess and the resulting credit crunch have acted as major stimulants to our commercial mortgage advisory business. Established owners and developers who previously would have picked up the phone and called one or two friendly bankers are now finding that the landscape has changed, and in order to get things done effectively in a banking environment still reeling from the Subprime mess, they need an experienced and capable jungle guide.
What are some of the biggest differences in today’s lending landscape? Back in early 2007 competition among lenders for development deals was so intense that the focus on Borrower experience and expertise, net worth, liquidity, and track record was diminished, and it was possible for “rookie” developers to get 80% or even 85% loan-to-cost construction loans. On large deals with an added layer of mezzanine financing, it was even possible to leverage up to 90% or 95% of the total project cost. Now, not only has leverage rolled back to more typical historicallevels (70% - 75% in most cases), but scrutiny of a developer’s credentials has been ratcheted way up. Now lenders REALLY want to know that a developer will have the CASH to lubricate the wheels of progress when cost overruns hit, or when it ends up taking another year to sell off or stabilize a project. Some lenders are now underwriting new condominium construction deals with a 2 ½ year interest reserve (rather than 2 years), in order to give a greater cushion if the sellout takes longer than expected. Predictably lenders are focusing more on a credible rental fallback scenario for condo deals, and they are underwriting the deals with higher debt service coverage ratios (in some cases looking for 1.3 rather than 1.2 DSCR). Of course, more than a few lenders have exited the condo market altogether.
For ground-up development deals: A meaningful track record, real liquidity and net worth are back at the center of lender’s radar screens. And did I mention liquidity? I cannot emphasize that enough! Non-recourse construction loans are fabulously rare but still available for strong developers with compelling, larger deals. However these days most construction lenders are looking for full recourse, and they are focusing on real liquidity to back it up. Even for large, established developers the noticeable effect of this more stringent credit market is the need to inject additional equity.
“Journeyman” developers and those that are “jumping levels” (for example going from doing 10-unit jobs to doing 40 or 50-unit jobs) must be prepared to pony up a minimum of 25% and in many cases equity of at least 30% of the project cost for mixed-use and multifamily deals. Exceptions will be rare and will usually revolve around the imputed land value for sites that have been held for some time.
Our firm has always focused on the capital stack from the top down: meaning focusing first on the equity and the quality of the development team then moving down the stack to arranging the debt. We have long viewed the mortgage as only one component of the capital stack. Because Winter & Company focuses on “high touch” challenging deals with a lot of moving parts, we are quite prepared, if needed, to bring a developer together with equity providers and joint venture partners. One of the refreshing aspects of today’s environment is that we are finding that developers are more willing to listen when we suggest beefing up their own equity and expertise with equity participations and joint ventures. Of course joint ventures are about much more than just money: J/V’s can also be a very effective way to address weaknesses in a development team and make a project stronger and more likely to succeed in these challenging times.
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