As Advisors, our role is to provide options to our clients that they may or may not know about or have considered in the past.
We have many developer clients chasing construction loans in an unending circle of rejections, deferrals, un-papered verbal quotes, or quotes at far lower leverage than expected.
I have personally been told, “I am sending this deal to you because my long standing relationships have lost their minds.” Meaning that there are some developments that should be highly profitable and make great sense, but their lenders are not interested. For me, its not the best way to take in new business, but I will take it!
We solve this problem, either with an ‘apples to apples’ loan which is a directly competitive set of options maybe with more dollars or longer term OR with a non-recourse construction loan. It comes at a higher price (rate), but in this case when you pay more, you get something for it. The leverage is generally very good too. We call this ‘throwing an orange into the mix’.
In 2009, when the lending world, as we knew it came to an end, the first casualty was the non-recourse construction loan. It made sense. As lenders were directed away from risk, the first thing to go should be the riskiest of all loans. Wachovia had a great program… as did a few of the others, but Wachovia was the best, in my experience, which is generally deals from $10,000,000 to $50,000,000. They were looked at as being trail blazers in risk.
What makes this loan more risky from a lenders standpoint?
Along with all the normal risks of making a loan, you have the risk of the construction world changing, contractors going out of business, litigation, and a risk that the market changes during the construction term which results in an obsolete building at CofO.
Has this ever happened? Yes, in our backyard. Many buildings that were built as condo’s, lost their buyers during construction, and became far over improved apartment buildings. Tenants had the ability to rent in a high-rise with the best finishes and amenities for less than most apartment rents during this time. Lenders got stuck with relatively low rents for high priced product… an obsolete building, at least for the short term. As a side, I remember hearing the commentators say that Miami had a 12-year inventory of condo’s in 2009, and that there would be no need for new construction until the mid 2020’s. Boy were they wrong…
What makes this loan more risky from a developers standpoint?
From a developers point of view, there is a hidden benefit. Many developers have gotten into trouble through no fault of their own. Lenders have been shut down or gone out of business mid construction loan, many times. The developer has draw requests unfulfilled, then they can’t pay contractors, and has nobody to go to for help. Nobody. Any years later, you are still in litigation, and judgments with your name on them are being traded by everybody who wants to reach into your wallet. With non-recourse, this will not happen.
Anyway, the non-recourse construction loan has been elusive. It has never been overly popular from a lenders point of view. Now, in a world where banks are regulated to very high degree, it’s not in the cards. So, the gap is being filled by private equity funds. Ha! Leave it to those greedy SOB’s on Wall Street to fill a void in the market that has a huge demand, and no supply. Now, there are a few suppliers, and the number may be slowly increasing.
In late 2016, I tied up my first fully non-recourse construction loan in years. Now, we have 2 moving toward closing, and a third that we are getting close on. By the time that I upload this, the first of these loans should be closed (see our Transaction section).
The fact is, typical construction lenders are not fighting over the business right now. Many are still waiting for some older loans to pay off, and others have ‘concentration issues’. Yes another reason is that lenders are saving their construction dollars for their Tier I existing clientele only. It is also a fact that we are winning this business based on the fact that it may end up being the clients only choice at certain leverage levels.
WHAT CAN YOU EXPECT
Here is what you can count on for a non-recourse construction loan in the $10,000,000 to $30,000,000 range:
Libor Floater with spread ranging from 6.50% to 9.50%
Added Advantages – These lenders are not banks. They are not regulated like banks. Their underwriting standards have more flexibility, and a common sense aspect that is refreshing. Not to say that all banks are rigid, but lets say that there is a wide range of rigidity from bank to bank.
Yes, it is more expensive.
Yes, from a developer’s point of view, it is generally better to not guarantee a loan.
And yes, this money is readily available for developers, who understand that risk and return have an inverse relationship.
As mentioned, we are Advisors. Our role is to provide options to our clients and put them into decision making mode. We advise our clients to stack up recourse and non-recourse offers against each other. Based on leverage, non-recourse will likely win a fair share. But it is an option which most have not truly considered before. Providing options is what we do.