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Mining for Land Loans

RECI, 20 November 2008, No comments
Categories: Education, News|Views

 

Chicago, Illinois, November 20, 2008 – In today’s extremely difficult funding environment, financing even the most straightforward types of commercial real estate projects proves to be tricky.  In fact, commercial mortgage originations are nearly at a stand-still as lenders attempt to sort out financing dynamics in such an uncertain funding environment.

Of all realty asset classes seeking financing, land loans are the most difficult to entertain.  Any mention of land loans is the equivalent of discussing financial toxic waste.  The current lending and regulatory environment demands any real estate collateral by secured with proven cash flow and limited leverage – neither work well with land loans.  Under such conditions, land loans are limited to high-risk funding sources demanding extremely pricing premiums. 

The highest rewards (and risk) are available in the land acquisition and development arena.  For the most part, land is burdened with carry costs and seldom has any income.  Future use, including economic feasibility and zoning are yet to be identified.  Also, land is immediately impacted by economic cycles.

Land development and entitlement are exclusively focused on the preparation of site preparation for further development.  Locational, physical, legal, and financial elements are interwoven including typography, environmental standards, change of use (zoning) and community concerns.

Most successful land development models are based on “wholesale” land acquisitions (unentitled, raw land) and “retail” dispositions to users, developers and investors. 

Typical formula or land development is based on purchasing an option for the land, the most profitable method.  The option money is used to explore various zoning and physical issues with the site.  Should the process successful, the developer can then use the remaining part of the option to purchase the land.  Alternatively, if the option is not available because of the land value, a developer needs to prequalify much of the main risk issues including zoning, entitlement, demographic: analysis and physical features such as environmental issues.

Under all of these scenarios, local presence in the market is crucial for success.  Some land deals may take three to five years before any results are shown.  Hence, many national firms use local development expertise to assemble and entitlement.

 Unanticipated problems (e.g., extremely costly environmental cleanup), unrecoverable expenses, cost overruns, illiquidity, lost time,  and damaged relationships with governmental local authorities/community groups are among the numerous issues influencing development yield profiles.  As a result, land development ventures often require overall returns of 25% or more.  Even at such yields, changing market conditions such as the current credit crunch and supply-and-demand dynamics make for highly elusive profits.

 While land investing is extremely challenging, financing is still available even in today’s restrictive lending environment.  In order of importance, current funding parameters are as follows: 

  1. Prime sponsorship required with proven track record strong financial statement well in substantially in excess of land value.
  2. Full Recourse required and additional collateral often necessary, including projects with current cash flow stream.
  3. Well below fifty percent or less of value based on recent valuations adjusted for currently depressed market conditions [e.g., 50% to 80% discount typical based on values of peak market cycle 2005-2007].  Lend in infill locations strongly preferred.
  4. Pricing reflects significant premiums as compared to any other real estate asset class.  Terms are similar to other business-lending parameters such as line-of-credit fundings.

  

According to the Real Estate Capital Institute’s Research Director, Nat Zvislo, “Land and development loans present the most challenging fundings.  However if conservatively underwritten, lenders see such loans as excellent opportunities for maintaining and building new client relationships during such difficult times.”

ABOUT US:

The Real Estate Capital Institute is a research organization staffed by industry volunteers who collect and track debt/equity rate data.  The Institute’s website provides daily and historical rates including treasuries and short-term rates.  The Real Estate Capital RateLine (773-227-4825) announces hourly rate updates throughout each business day.

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Las Vegas, NV - February 6, 2010 - According to industry leaders gathering in Las Vegas this week, debt capital is readily available for 2010.  Optimism is in the air and the mortgage lenders are starting to offer more generous terms and conditions.  In summary, timing is excellent for select borrowers in securing debt based on the following conditions:  (1) Recovering economy, (2) Ample supply of capital and (3) Limited supply of financeable real estate assets.  The following highlights summarize the 2010 state of the realty capital markets including an overall outlook and overall funding program offerings:  Back to Basics:  As lenders workout of their legacy problems, new funding goals surface which are clearly more ambitious than 2009. Still underwriting of actual numbers w/o projections, yet inflation fears exist. Most lenders are Indifferent to spreads, but not competition. Valuing real estate properties in a declining market still a challenge. More allocation of funds available above target amounts if deal flow is of sufficient quality Underwriting Dynamics:  As has been the case last year, high-quality projects in major markets backed by excellent sponsorship and cash flow characteristics are most desired—especially based on low leverage of 65% of value.  Location/Property Types: Major MSAs strongly preferred for optional pricing and leverage.  Otherwise a substantially most costly financing with lower leverage. Preferred property types ranked in order:  (1) Multifamily, (2) Credit-Tenant lease of all property types, (3) Industrial, (4) Retail, (5) Office - however medical office ranks equal to Industrial and (5) Lodging. Pricing (Permanent Fixed-Rate Loan): Agency pricing for apartments starts in the low to mid-5% range for 5 year or greater term. Life company pricing starts mid-5% to 6% for 5 years or more term mostly targeted for commercial property pricing (agencies are more competitively priced) More entrepreneurial funds start at 7% or more targeting secondary markets, smaller fundings, older properties and lodging assets. Add a pricing premium of 25 to 50 basis points for loans below $5 million. Yield differential disappearing - typical ($5 to $50 million) vs. larger loans. Forward funds available up to a year based on 6 o 8 basis points premium per month.  Leverage: Above 65% LTV on a select basis combined with lower spreads. Values based on the lower of: (a) purchase price, (b) appraised value or (c) lender imposed capitalization rate.