Cautious lenders are drilling down to details

Real estate developers now require a proven track record and more precise information

By
Western Investor
April 30, 2019





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Though it is tougher, real estate financing is certainly available in 2019. What borrowers need is the proper expectation as to what lenders are looking for.

Each commercial real estate asset class is different, but it all starts with the land.

With recent increases in land valuations based on a cost-per-buildable basis, institutional lenders are taking a breather depending on who the purchasers are and their experience, and where the lender’s own portfolio is currently sitting from a risk/liquidity standpoint.

Lenders will start an application by considering who the borrowers are and what past exposure they have had. Lenders are looking for familiar names with experience in executing projects, and they want to work with borrowers who know how to properly value a project and take it to completion.

Lenders have many internal risk categories that factor into their decision-making for land financing. Some of these factors include: their current level of existing land loans relative to their total portfolio; the conversion of land loans to construction mortgages; construction files, geographical exposure and concentration; and final post-construction asset type (residential or commercial inventory).

Lenders provide a valuable service to borrowers and naturally want to efficiently transition their non-income supporting land portfolios to their construction portfolio within a shorter period of time (think 12 to 18 months).

In times like today when there are increasing regulatory requirements, liquidity constraints combined with substantial borrower demand, and limited supply, it is simple economics that financing costs for land acquisition have gone up. We are also seeing increased lender due diligence as lenders are deploying their limited funds into the best projects and strongest borrowers.

The important aspect here is for borrowers to understand these critical elements when it comes to financing. Plan for success and be prepared (yes, the onus is on the borrower), and put together a comprehensive financing proposal that addresses all aspects of the project. 

Financing brokers are experts in creating proposals and conducting in-depth discussions with prospective borrowers about their projects. A good broker can quickly analyze the proposal and take factors such as development experience, construction budgeting and financial analysis, critical timelines and market absorption of the end product, plus exit strategies, into consideration. 

Based on the strengths of these items, brokers will work with lenders and borrowers to set the right expectations on rates, fees, collateral and covenants for the mortgage. 

Strata pre-sales 

Pre-sales for strata construction, whether commercial or residential, are a key element for lenders as they represent the “repayment” of the construction mortgage and the exit strategy for the financing, and demonstrate market absorption for the proposed inventory. In these times, lenders are asking for higher pre-sale requirements to prove out the financial viability of the development. That said, there are lenders who, for an extra cost, are willing to reduce their level of pre-sales, but the lender will have to be comfortable with the borrower/developer’s experience and comfort with executing the project. As important as pre-sales are, borrowers/developers should not overlook their hard cost budget as we’re seeing this as a larger issue for our clients.

Multi-family financing 

Mortgages insured by Canada Mortgage and Housing Corp. (CMHC)are highly attractive financing options used in the purchasing of existing rental buildings and the construction of new multi-family rental housing. The best CMHC rates available at the time of writing are the fixed five- and 10-year rates of approximately 3.06 per cent and 3.3 per cent, respectively.

Rental apartment buildings are often viewed on the lower end of the risk spectrum by commercial lenders due to stable and predictable cash flows. This is especially true in ultra-low vacancy rental environments.

 

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