Spotlight on Construction Financing

This month’s Spotlight focuses on multifamily construction financing. The continued maturity of the commercial real estate construction cycle has led lenders to be more careful in their construction financing decisions. Lenders are increasingly focused on the quality of projects through evaluating sponsorship, location, project site, and other factors that have resulted in reduced leverage on large construction projects and more conservative underwriting. To this point, there has been less of an impact on smaller development projects.

Additionally, internal and external speculation on the impact of the next phases of Basel III requirements continue to keep lenders in check. Basel III’s regulatory framework is intended to reinforce bank capital requirements by increasing bank liquidity and decreasing bank leverage. The impact of these regulations can commonly be felt by developers with significant land equity who are now required to secure greater cash equity prior to construction. Although FHA and other government supported programs provide construction financing on multifamily assets, developers continue to have a preference towards balance sheet lending, if available.

Multifamily Construction Loan Overview

• Rate: Typically a floating rate with a spread over LIBOR or sometimes prime on smaller projects.
• Term: Term is usually set for the construction period with a potential mini-perm feature after construction is complete to allow for lease up and stabilization to then refinance or sell.
• Loan-to-Cost: Construction loan amounts are typically based off of the total cost of the project. Typical LTCs range in the 60-75% range depending on location, sponsor, and other factors.
• Recourse: Higher leverage loans are most likely going to be recourse, although it is possible to get limited or non-recourse financing depending on the amount of leverage and the quality of the sponsor. Guarantor liquidity and net worth will be closely evaluated in relationship to the requested loan amount.
• Underwriting: Lenders are utilizing lower leverage and more conservative underwriting assumptions and will closely evaluate project budgets, development team, pro formas, project site, and timelines in evaluating the financing opportunity.