chapter 18 acquisition, development, and construction financing © oncourse learning

Chapter 18

Acquisition, Development, and Construction Financing

© OnCourse Learning

Chapter 18 Learning Objectives

Understand that a large proportion of the covenants and restrictions contained in loans to finance the acquisition and development of commercial properties are directed at agency problems

Understand those loan provisions that are common to commercial developments

Understand the basic mechanics involved in determining the loan amount and periodic disbursements

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Acquisition – The Land Loan

Acquisition of raw land by two types of investors – the speculator and the developer

Speculator Has no development plans for the land

Sees an opportunity for price appreciation because of growth constraints, zoning changes, etc.

Developer May specialize in developing different property types

Has immediate plans for the land

Will proceed as quickly as possible


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Warehousing Holding of large parcels of properties in advance of

the development process by large developers especially those specializing in large residential developments

The developer creates residential developments in a continual process

Financing important as the developer desires to tie up as little equity as possible in large parcels of land

Institutional Lenders Commercial banks and thrifts are main sources of land financing

As local lenders they are in the best position to judge the risk involved a land loan

Land acquisition loans are risky No operating income

No depreciation of land; few tax benefits

Physical suitability

Cost of preparing land for development may be unexpectedly high

Legal factors (zoning changes)

Loans seldom exceed 50% - 60% of the appraised value of the land


Institutional Lenders A financial institution making a loan on a raw land will

have a lien on the property as collateral for the loan Release Provisions – if the land is to be used for

residential development, provisions made for release of a portion of the land from the lien of the financial institution

Partial release provision Provisions that after a significant portion of the development

has been sold the value of the remaining land is greater than the remaining amount of indebtedness

Mechanics handled in escrow


Seller Accommodation

Seller – another source of land acquisition financing

Seller financing through option financing, seller financing and subdivision trusts

Land purchase option Loss = option premium if option not exercised

Cost (option premium) based on term of the option, period of exercise, and volatility of land prices

Rolling options

Additional options on more land as existing options are exercised


Seller Accommodation Seller financing by seller taking back a note from the

buyer The seller’s note is subject to an increase in risk through the

subordination process

Subdivision trusts The developer puts up only a portion of the sales price and

agrees to pay the balance when the property is developed and sold


Development Development steps include:

Zoning

Engineering and surveying

Subdividing

Physical work

Use of land development loan

Obtain government approvals Subdivision control ordinances

Dollar-based impact fees, including cost recovery fee

Non-dollar-based impact fees - exaction, density bonus, inclusionary zoning, tax increment financing


Construction Loan

Short-term over construction period

Interest rate is variable and usually over prime

Interest payments are deferred

LTV ratios in the 70 to 80 percent range for commercial projects built for sale, and 60 to 70 percent for speculative projects


Risks in Construction Lending

Unfinished or partially completed projects

Unknown construction risks such as weather, prices, strikes, etc.

Mechanic’s liens, personal injury, etc.

Permanent lender commitment failure

Failure to meet building codes


Construction Loan Commitment A separate agreement whereby the lender makes commitment to make a loan

in exchange for a fee To be enforceable in court the agreement should be as specificas possible and

contain no vague language Terms covered:

Loan amount Interest rate Description of collateral Commitment and details of permanent loan Developer’s equity at the construction phase Requirement for securing rental agreements with major tenants Statement of personal liability in case of default Statement that the commitment is not assignable to another party


Construction Loan Provisions

Reference to the promissory note

Construction procedure details

Loan disbursement details

Designed to insure expeditious construction, within budget and without additional liens


Construction Loan Administration

Making sure that Construction proceeds as scheduled

Construction work conforms to specifications

Cost overruns are avoided

No other liens supercede the lender’s

Permanent lender conditions are not violated


Construction Loan Disbursement

Lender requires that the developer puts some equity into the project

Developer wants to draw funds only as needed

Interest accrues to borrower to the end of the loan

Lender will usually charge a contract rate plus loan fees and points


chapter 18 acquisition, development, and construction financing © oncourse learning

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