Bison Financial Group principal, David Repka, was recently interviewed by a national commercial real estate publication to discuss his views on where the Construction Financing Market is headed in 2020....
Q: What are your predictions for construction lending going forward?
A: In the Fall of 2019 I attended the Crittenden Commercial Real Estate Finance conference in Miami. One statistic stood head and shoulders above the rest: NYC is the largest construction market in the USA and 4 of the top 5 construction lenders in NYC are debt funds, not banks. Let that marinate for a moment. What this means to me is that banks have been over-regulated out of the construction lending business. Debt funds and non-bank lenders have stepped up to fund construction projects going forward. I don’t see this changing anytime soon.
Q: What will be the biggest changes/trends in construction lending in the next six to 12 months versus years past?
A: Where is the equity going to come from? In a post Great Recession world senior debt from conventional construction lenders tops out at 55-65% leverage. This new normal is compared and contrasted to 75-80% leverage a decade ago. Investors/Developers that seek higher leverage need to seek out alternative sources of capital and be willing to pay a higher interest rate and origination fees. We are seeing significant interest in capital stacks involving mezzanine, preferred equity, and C-PACE to add additional leverage to fill this funding gap.
Q: How will construction lender underwriting change going forward?
A: We see a barbell shaped market with very high quality opportunities on one side and challenged opportunities on the other side. Best in breed sponsors will continue to attract construction financing because they are able to capitalize their deals with 35 to 45% equity. We are seeing a market acceptance of C-PACE financing to provide about half the required equity. Construction lenders are getting more savvy on how C-PACE plays into the project’s capitalization. C-PACE is looking for a coupon rate of return in the 6-7% range as opposed to traditional mezz/pref equity seeking 15-25% IRR.
Q: Which properties/projects will lenders target for construction? Why?
A: While there are exceptions to every rule, construction lenders are primarily seeking to lend on multifamily properties and single tenant net leased (STNL) properties. Market rate multifamily, workforce housing, and 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 will be the typical LTC on a construction loan?
A: Setting aside STNL deals that can be funded to 100% LTC, conventional investment properties are being funded at 55-65% senior debt via banks and 65-75% LTC with non-bank lenders. More exotic financial structures utilizing mezzanine, preferred equity, and/or C-PACE can push all-in leverage to 80-90% of cost.
Q: What will be the typical construction loan rates? Points?
A: Rates will depend on risk, risk depends on leverage. Pricing for 55-65% LTC senior construction debt via banks is in the L+200-350 range with the delta dependent on the experience, NW, and liquidity of the Sponsors. Pricing for 65-75% LTC with non-bank lenders is L+350-650 for multifamily and L+750-900 for specialty projects like hotels, for-sale condominiums, and STNL properties at 100% LTC. In all cases a one to two point fee to the senior lender is typical.
Q: How much recourse will construction lenders require?
A: There are four major types of recourse: Completion/Performance, Loss of Interest, Loss of Principal, and Bad-Boy Acts. All lenders will require recourse for Bad Boy acts such as fraud, misrepresentation, and theft. Due to the nature of a construction project lenders will require various levels of recourse for completion of construction/performance. Many times this risk can be shifted to a general contractor with a Guaranteed Maximum Price Contract and a bonding package. Depending on rate and leverage non-recourse terms can be negotiated for financial default due to negative cash flow or sale at a loss.
Q: What specific markets will see the most construction financing activity?
A: Sunbelt (smile states) with strong job creation.
Q: What markets will construction lenders shy away from? Any markets overbuilt?
A: Lenders will continue to monitor job creation. When job creation slows or reverses, it will be difficult to borrow capital for new construction.
Q: What will lenders want to see from the borrower/developer? (certain net worth and liquidity, certain number of properties under their belt, etc.)
A: Senior lenders will continue to drop leverage until they are comfortable with their basis. 55-65% senior leverage is the new normal. The rule of thumb is that Sponsors need to have a net worth of 1 to 2x the construction 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, will need to pay higher rates to compensate for the risk, or attract another piece of the capital stack via mezz or pref equity.
Q: What specific lenders will be active in construction lending this year? (We don’t direct quote, specific names please)
A: Wells Fargo, US Bank, Madison Realty Capital, Related, Trez Forman, BridgeInvest
Q: What specific banks will be active construction lenders this year?
A: Wells Fargo, US Bank, Bank of America