Underwriting Criteria More Stringent, Yet Realty Construction Funds Available
Chicago, IL -- (ReleaseWire) -- 09/27/2007 -- Given this late summer's tumultuous realty capital markets and property oversupply concerns (e.g., retail and residential), borrowers are often puzzled about how new construction loans are underwritten.
Conventional wisdom dictates the most important factors for underwriting and funding a construction loan include the basics: equity, borrower financial status, location and project costs/physical characteristics and projected economics. While these variables are fundamental for underwriting a loan, questions remain as to the specific details for approving a loan at the “correct” level.
Not every lender has a “secret black box” for sizing loans. However, some clear underwriting trends are emerging, including the following:
1. Completion guarantees are supplemented with full recourse, even after project completion.
2. Where applicable, more stringent preleasing requirements to generate at least breakeven cash flow on debt service.
3. 120% or more debt service coverage ratios applied on "stress test" mortgage constants (within the 7.5% or more range) which replacing capitalization rate valuations for calculating leverage underwriting restrictions – generally translating to loans of 75% or less of appraised value based on stabilized cash flow analysis.
4. Extremely wide pricing variations with a range of 150 basis points or more over the floating-rate index --- typically LIBOR.
5. More costs as a minimum fees are increased (typically 1%) and other incentives reduced, or removed, such as discounted legal and third party processing fees.
6. Existing clients receive greater preferential treatment as lenders are more selective and cautious regarding new client relationships.
7. Given this month's LIBOR volatility, other indexes are negotiated (e.g., Prime, treasuries.)
8. Exotic financing vehicles such as mezzanine, preferred equity and other high-leverage are shunned. Projects need to have "clear and simple" equity.
The research director of the Real Estate Capital Institute, Nat Zvislo says "Construction loans are summarized as more, more, more…More preleasing, more equity, more yields, more fees and more guarantees." Adding, "All factors equate to less risk."
The Real Estate Capital Institute® is a research organization studying domestic debt and equity markets for commercial properties. The Institute's website (http://www.reci.com) offers various information on fixed and floating rate debt pricing. Interest rate updates are available on an hourly basis by calling the Real Estate Capital Rateline at 1-7RE-CAPITAL.