Bison Financial Group principal, David Repka, was recently interviewed by a national commercial real estate publication to discuss his views on where the land loan lending market is headed in Q4 2022....
Q: What are your predictions for land lending going forward? For 2023?
A: In the Fall of 2022 I attended the Crittenden Commercial Real Estate Finance conference in Clearwater Beach, FL. One comment stood above the rest: many conventional lenders have stopped lending to new customers. They are reserving balance sheet loans for only their best in breed, existing clients. Look for this trend to continue and trickle down from the large global banks to small community banks. Look to debt funds and non-bank lenders to do the majority of new land loan originations for 2022, 2023 and beyond.
Q: What will be the biggest changes/trends in land lending going forward verses years past?
A: Where is the equity going to come from? In a post Great Recession world land lenders topped out leverage at 55-65% leverage. As sources of senior debt on land narrows, leverage will drop and rates will go up. Look to max leverage being 50% of quick sale value. The balance of the capital stack will need to be pure equity.
Q: What will be the biggest changes in underwriting land loans going forward?
A: Lenders will be hyper focused on their basis and if they are willing to own the property they are being asked to lend on for several years if the borrower’s business plan fails and they default on the loan. Covered land plays in which income can be derived from a current use will get the most attention from conventional lenders. Properties without an in-place income stream to service the debt until entitlements can be won will find it very difficult to obtain financing from conventional lenders and will need to borrow from non-bank lenders. Lenders of all varieties will take a deep dive on a borrower's Schedule of Real Estate Owned and Global Cash Flow before sending a term sheet.
Q: What will lenders require for a land loan? Does it need to be entitled for a certain property type? Number of Acres? Location?
A: Lenders will first look to their basis for comfort and then to the financial guarantees available from the borrower for repayment. Borrowers with a strong paper net worth, but low liquidity and sporadic global cash flow will find it extremely difficult to borrow in this environment. Properties that are not as-of-right for the intended use that will need several years and hundreds of thousands (or millions of dollars) spent on lawyers, engineers, and consultants to properly entitle for the intended use will find it very difficult to secure financing in this environment. Properties with an immediate path to development will have the highest probability of securing financing. Property types in favor include multifamily rental properties and single tenant net leased (STNL) properties. Market rate multifamily, workforce housing, and age-restricted senior housing are all attracting funding from construction lenders. In the STNL space there has been a realization by a select number of non-bank niche lenders that 100% LTC financing is actually a pretty low risk loan and can command pricing in the high single/low double digits. Lenders in this space require three things to mitigate their risk:
- proof of site control of the property to be developed
- fully executed lease with no outs from a tenant they like
- shovel ready site with all municipal approvals, land use, zoning, entitlements, and permitting with no open issues of any kind
Q: What are your predictions for unentitled land loans going forward? What will it take to get this funded?
A: Land is the riskiest possible real estate investment category. While it is possible to earn fabulous profits by upzoning and selling a property in a rising market, the negative cash flow of owning an asset with only expenses and no income will make this a “Rich Man’s Game” once again. Investors with strong global cash flow from a portfolio of stabilized, income-producing properties will be able to borrow money secured by land because the loan is in reality secured by a diverse portfolio that generates positive global cash flow. The “Recession of 2022” will contract lending to weak handed, less experienced borrowers that don’t have the financial strength to ride out the storm.
Q: What will be the typical leverage on a land loan?
A: Covered land plays will be able to achieve 60 to 65% senior debt via banks and 65-75% LTV with non-bank lenders. For properties without an income stream, look to a max of 50% LTV with a very compelling reason needed on why the loan should be made. A compelling reason could be a contract or LOI in hand to sell off a portion of the property to retire a portion of the loan and reduce the lender’s basis.
Q: What will be the typical rates on these deals?
A: Rates will depend on risk, risk depends on leverage and Sponsor’s track record and financial strength. Pricing from a conventional lender is in the SOFR+300 to 400 range with the delta dependent on the experience, NW, liquidity, and global cash flow of the Sponsors. Pricing with non-bank lenders starts at SOFR+600 with many hard money lenders quoting SOFR+800 with a floor of 10%. As of this writing 1-Month Term SOFR is 3.125%.
Q: How much recourse will construction lenders require?
A: There are four major types of recourse:
- Loss of Interest
- Loss of Principal
- Bad-Boy Acts
All lenders will require recourse for Bad Boy acts such as fraud, misrepresentation, and theft. Conventional Lenders will most likely require full recourse across all four categories. The only way to soften this recourse requirement is extremely low leverage (think 20 to 25% of quick sale value). Non-Conventional lenders will make loans that require recourse events for re-balancing an interest reserve and if extremely comfortable with their basis will not require recourse for loss of principal.
Q: What specific markets will lenders be the most comfortable with land loans? Any markets lenders will shy away from funding a land loan? Why?
A: Sunbelt (smile states) with strong job creation and in-migration will get the most interest from land lenders. Lenders will be extremely cautious to lend in markets with a notoriously long, arbitrary and capricious permitting/entitlement process.
Q: What will the lender want from the sponsor on a land loan? (certain net worth and liquidity, other assets, etc.)
A: Senior lenders will continue to drop leverage until they are comfortable with their basis. The rule of thumb is that Sponsors need to have a net worth of 1 to 2x the loan amount and post-closing liquidity of 10-20% of the loan amount. So there is no ambiguity, if we are requesting a $20 million loan, the Sponsor will need to have a NW of $20 to 40 million with $2 to $4 million in post-closing liquidity. Sponsors that can not meet these guidelines will either not attract financing, or will need to pay much higher rates to compensate for the risk or find ways to mitigate risk such as negotiating a sale of a portion of the property prior to financial close with the new lender. We are seeing lenders extremely focused on the global cash flow of the borrower. Does the borrower have a logical & predictable income stream from a portfolio of mature, stabilized assets? Or does the borrower earn money sporadically from doing deals and making a flip profit?