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Most lenders will finance a portion of total land-development costs. In fact, it's not unusual for lenders to finance as much as 65 percent of the land acquisition and 100 percent of the hard costs and also allow for an interest reserve. If the bank is lending 73 percent of cost, for example, your borrowers must come to the table with the other 27 percent. This can come in the form of a seller-held second note, cash equity or both.
Once your borrowers have a note and are ready to move forward with the loan, the lender will issue a letter of interest. When your clients sign off, the lender will order an appraisal and begin due diligence.
This period includes the appraisal, title work and possibly an environmental report. When dealing with raw land, the lender will want to make sure that there are no pre-existing environmental hazards that may cause litigation. If the borrowers are developing an area that has always been used for residential purposes, it may not be an issue. But if, for example, they're developing farmland where pesticides may have been sprayed, the bank will want more information.
The appraisal, as always, will be an important component of the transaction. Most reputable construction and development lenders will lend as much as 80 percent of the "as complete" value of the project. That doesn't, however, necessarily mean the lender will let your clients borrow as much as 80 percent of final value. They may have other guidelines that govern the lending limit.
Assuming the appraisal and third-party reports check out, the lender will turn its letter of interest into a formal commitment to lend. A draw schedule will be created, and you'll move toward a close.
Exit strategy and funding
The main thing the lender will be concerned with is the developers' exit strategy and how likely they are to perform.
With horizontal-development loans, the exit strategy is always the same -- improve the land, increase value and sell the lots to builders.
It's an easy concept to grasp. Even though development involves a different kind of risk, there's an established market, and there are lenders who feel comfortable with that.
As work progresses, the bank will fund the money as agreed in the loan contract. Assuming the project finishes on time and on budget, the land will be improved, the lots will be prepared for sale and the developers will likely begin marketing efforts to drive sales.
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If you're just getting started in construction financing, maximize your time and profits. Consider starting with developers who work on a few acres at a time. The loan amounts may be smaller, but these builders will often turn projects over several times a year. That means repeat business for you.
That's not to say you couldn't land a big deal on your first project, but you might want to get familiar with the process before you hit for the fences. It is a highly localized and competitive market.
Ultimately, developers with a good team behind them -- think real estate attorney, engineer, architect and real estate agent -- will be most likely to complete their projects.
All that's missing is a good mortgage broker to help them find the funding.
Craig Grella, principal, Cornerstone Funding Services Inc., started his career as a civil and structural engineer.
Working with developers made him aware of the challenges of commercial and development financing. As such, he transitioned from designing projects to financing them, working as a senior loan officer with several national banks. Grella later co-founded Cornerstone Funding Services, a full-service real estate consultancy with offices in Long Island, N.Y., and Seattle. Contact: (800) 928-0845, www.cornerstonesvs.com.
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