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CRE construction lending

Whither CRE Construction Lending?

By: Justin Laub

The mantra of commercial real estate developers around the country when speaking of the state of construction lending these days might be: ‘you don’t miss something until it’s gone’. Though we are not witnessing the complete shutdown of the construction lending industry, we are certainly witnessing a pause in, and a shuffling of the market. The tightening of the construction lending market that began as a  trend a year ago has now become a permanent fixture in today’s capital markets. Though projects are still being financed, lenders are now pickier about what they finance and the terms on which they do so. The result is that it now takes more creativity to convince lenders to finance development deals

You may wonder what is driving this changing trend? There are multiple factors. The main drivers of this trend are: i) The Dodd-Frank banking regulations that penalize banks for overextending on construction lending, ii) the sheer volume of development projects over the past three years that have absorbed much of the lending industry’s construction capacity and iii) concern amongst lenders that we are late in the cycle. All together these create the situation we are in today, whereby the reins have been pulled in on construction lending. A new wild-card in this equation, is the new Trump administration. With the possibility that they may roll back Dodd-Frank (and other) regulations as well as the post-election surge in consumer and business confidence, there is the possibility of significant change. That however, would be the subject of a separate blog.

It’s difficult to precisely quantify how much construction lending has tightened as a result of all of the above, but I would estimate that Loan-To-Cost (LTC) levels have tightened by 5-10% when comparing deals then and now on an apples to apples basis.  Perhaps a  better way to describe the situation is to say that projects at the margins (i.e. new sponsor, out of the box product type, pioneering locations, etc.)  are harder to get done these days. Banks are still lending on institutional quality deals at similar, conservative leverage levels as before, albeit it may be 5% less in LTC. Non-institutional deals however, are tougher to finance in today’s market. I would estimate that sponsors need to put anywhere from 5-15% more equity into their deals to get them across the line. Even so, greater equity doesn’t always make a viable, non-institutional project financeable in today’s market.

So what are the solutions? The alternatives today basically fall into two categories: i) you deleverage your project, or ii) you find alternative capital structures and/or capital sources to get to the leverage that you want. The first solution is straightforward, in that you simply put more equity into your project. The second solution, however, requires more creativity. There are a handful of one-stop shop, non-bank construction lenders that can get you higher leverage in exchange for a premium rate. There are also various combinations of bank and non-bank capital sources that you can combine into senior/mezzanine and senior/preferred equity structures in order to get to the leverage that you want at potentially more attractive pricing options than a one-stop shop. Regardless of what your solution is – less leverage or more creativity – the marketing effort to secure a deal today is more challenging than it was a year ago.

For strategic advice on your next development project, you can reach Justin Laub, Senior Director, at jlaub@metcapital.com. Or visit the Metropolitan Capital Advisors website at http://metcapital.com.

The author, Justin Laub, is a Senior Director in the Dallas office of Metropolitan Capital Advisors.

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