Credit Tenant Development Real Estate Loans:
The market has seen an increase in investments in the single-tenant market. Regarding credit tenant development real estate loans, developers in the past have enjoyed access to capital through their personal banking relationships. A few years ago a developer could finance up to 85% to 90% of the construction costs with the assumption the “as completed” value would be closer to 75% or lower leverage. Today most banks do not advance at these higher levels due in part to banking regulations that came about post-2007-2008 financial crisis known as High Volatility Commercial Real Estate or as known in the industry as “HVCRE.”
I read an interesting article in National Real Estate Investor titled “Do you Have the Right Capital Partner for Your Net Lease Development Project?” Follow this link to this article:
While a banker can still originate these development loans at leverage higher than 75% loan to cost the banks must put more of their liquid equity aside towards the overall loan loss reserve. For example, if a banker was required to reserve $1 million for a commercial real estate loan at 75% loan to costs, at 85% loan to costs the bank must now set aside $1.5 million. This effectively increases the cost of funds for these higher leverage transactions. Additionally, the bank can expect higher scrutiny from the bank examiners with regards to these high leverage loans. Most banks have elected not to exceed the 75% loan to costs.
What options do developers have when trying to develop a single tenant property supported by a long-term lease from a financially strong and/or a tenant that carries investment grade public credit ratings when they fall short of the equity required by their bank? We have investors and lenders not subject to the HVCRE rules and are prepared to advance capital to help the developer complete the project and allowing the property to be sold to the open market.
We have lenders that will advance on a case-by-case basis up to 100% of the third party construction costs for a term between 18 and 36-months with the idea the property would be sold or refinanced within the 18 to 36-months of completion. These lenders will consider construction loans as low as $1 million. Other lenders can provide a forward takeout commitment upon completion that would provide 90% of the total construction costs, this lender would charge 5% per annum (preferred return) generally paid from the rental income, and share 50/50 in the profits over the original debt when sold. These lenders can handle multiple investments at the same time.
While the pricing and profit sharing can seem expensive, one must look at this as equity and not just a typical bank loan. What would you have to pay someone else for 50% of the required equity? Use this approach when comparing the costs of these specialized loan products.
Once the project is constructed Caffrey & Company LLC has dozens of lenders offering fixed rates, often on non-recourse and recourse loan terms.
We are often asked how much of a loan could be borrowed on one of these single tenant loans. The focus will be on a) the financial strength of the tenant, b) how much of the loan could be amortized during the primary lease term, and c) if a balloon balance what would the underlying real estate be worth at the expiration of the lease assuming the tenant does not renew? Most lenders would like to see the loan paid off at or before the lease expires. Some lenders will consider having a balloon balance at the end of the primary lease term. Borrowers often ask how much of a balloon balance. There is no set formula to determine the balloon balance. What could the property quickly be sold for assuming additional years or wear and tear and vacant? This gets into the market value of that particular piece of real estate. When running the numbers and backing into a balloon balance ask yourself would you jump at the opportunity to purchase this property with the additional years of wear and tear assuming the property is vacant at the balloon balance? If the answer is no then most likely the lender will want to pare back the amortization to reduce or eliminate the balloon balance.
As a guideline, some lenders assume they would be willing to have a balloon balance not to exceed the unimproved land value. Another lender, (only lends in markets with population centers in excess of 1 million) would generally consider going out 7-years beyond the primary lease term with a balloon balance.
Whether you need help with the construction or the permanent financing of your single tenant property please let Caffrey & Company LLC arm you with options help you reach your goals.
Mike Caffrey – President of Caffrey & Company LLC email: Mike@CaffreyLoans.com