Solutions in Short-Term Construction Financing

Real Estate Weekly, March 15, 2000 by Sanford S. Herrick

 

 

Nationally, the construction market is booming, with many sources of conventional financing available to owners, developers and builders. However, for a variety of reasons, some construction projects may require alternative financing sources. High-yield lenders like SWH Funding Corp. of Hackensack, New Jersey, can provide a valuable resource at any time during the life of a construction project.

 

High-yield (or hard-money) loans are short-term bridge loans. They can sustain a project in a variety of stages, from the approval process to pre-site work and demolition, to ongoing construction and completion. In fact, construction projects can encounter financing problems at any stage and as a result of a variety of circumstances. The high-yield loan can fill a gap, save a deal when the contract is about expire, or keep the contractors working. High-yield loans also provide the bridge, allowing time for due diligence and to obtain conventional financing.

 

For example, one of our first construction loans involved a new medical office building to be used by a health care provider. The building was 35 percent complete when the bank that committed to take-out the original construction loan withdrew because the tenant's credit dropped below the bank's threshold. In turn, the construction lender pulled out as well, and the builders had no ability to obtain conventional funding. They found us through a broker, and we committed and documented the deal in seven business days.

 

When timing is critical a high-yield loan works well.

 

With many construction projects, the ability to evaluate and respond to a complicated loan request in a matter of days is often essential. Yet in that short time frame, a tremendous amount of analysis must take place.

 

First, the merits of a project are examined in their entirety, and because high-yield lenders typically fund problematic and opportunistic projects, the capabilities, character, and history of the principals are scrutinized to ensure that the principals are totally committed. Environmental experts, appraisers and engineers are retained to evaluate the feasibility of a project and contribute to the due diligence process in a time-efficient manner. In addition, prior to closing, a construction loan administrator may look at a building, see how much has been accomplished to date, and work with the borrowers and construction managers to assess how much it will cost to complete the building. Market factors are also evaluated to determine the potential of a construction project. If studies already exist, the process is quicker.

 

Hard-money lenders must also be careful in structuring a construction loan, to establish reserves to use money as it is needed and ensure that it is properly allocated. Inspections at every drawdown further minimize the risk and contribute to the progress of a project. Payments may be supervised through lien waivers from contractors or subcontractors to monitor the progress and the work that is still outstanding.

 

Equity requirements, interest rates and fees

 

Every high-yield lender has its own set of unique requirements and structures. On all transactions, however, new borrower equity is critical. High-yield lenders are not as interested in how much money has already been invested in a construction project, because in reality, that often represents lost money. Borrowers come to high-yield lenders typically with a problem. Either they are not qualified for conventional financing, or the project has trouble. If the borrower puts in new equity, that proves to us his or her intent to complete the project. Typically the range from the borrower is 10 to 20 percent of the overall capitalization of the project, but the amount will depend on each individual case and on the quality of the real estate. In general, construction projects require more equity than income producing assets because by their nature, construction financing projects involve more immediate and varied risks.

 

The advantage of using a high-yield lender is that typically a builder has pressures when they come to the lender - perhaps a contract is about to expire or vendors need to be paid. We take the immediate pressure off. And while interest rates on high-yield loans are significantly higher than conventional loans, they are typically less expensive than introducing a partner. However, they are designed to be short-term, because hard money is expensive. In addition to interest, clients typically pay a due diligence fee of one percent and closing fees of four to eight percent. Broker/banker fees, third-party reports, the appraisal, and attorney's fee are often charged as well. As a result, typically a high yield loan term will be one to two years. The goal of a hard-money lender ultimately is to succeed and get paid back as quickly as possible. Although we don't have a take-out commitment, our borrowers must have an exit strategy. In general, traditional sources of conventional financing are always the first optio n a builder should consider at any stage of a construction project. But if traditional sources dry up, or if timing is critical, the high-yield option can often make the difference between a proposed construction project and one that reaches completion.

 

COPYRIGHT 2000 Hagedorn Publication

COPYRIGHT 2001 Gale Group