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Brokers can ease these fears by encouraging borrowers to contract qualified, outside consultants to prepare independent cost evaluations. This displays a willingness to open projects to outside scrutiny and criticism, while allowing borrowers to address any issues before approaching lenders.
There are several other things that brokers can suggest to borrowers to stay on top of costs:
Identify issues early: Overlooked costs at a project's inception can create expensive overruns and lead to construction delays, which seriously hurt project finances. There are tools, however, that can identify future costs.
For example, with a digital grading analysis, the amount of dirt that needs to be moved for a project can be measured accurately ahead of time to help avoid the expensive costs of importing or exporting dirt. Developers can identify and control other major costs early on including utility capacities, street plans and storm- drain requirements.
Determine requirement thresholds: By keeping the size of a project in check, brokers can help their clients cut costs. For example, reducing project density can negate the need for construction of a larger road or extra parking. Changes in the development plan can save substantial offsite costs or reduce the need for expensive municipal requirements such as additional parks.
Keep the cost estimate accurate and current: Changes in the plan also change the costs, and that should be reflected in the budget. Prices of raw materials and labor fluctuate and can fall in a declining market. Update budgets monthly or quarterly.
Mitigating financial problems
Unfortunately, even with diligent preparation, developers sometimes encounter problems. Lenders consider the likelihood of these issues when they evaluate loans.
There are a number of options, however, that brokers can use to steer developers' projects away from risk:
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Use creative escrow: Developers can enter a longer-term escrow, allowing for the close of escrow to occur 35 days after approval of a subdivision map. This approach might complicate the sales process, but it should decrease entitlement risk.
Seek various funding avenues: Because smaller loans are easier to get, brokers should look for ways to decrease funding needs by using public-finance tools. Developers can apply for government grants that encourage sustainability, energy efficiency and green building to lower construction costs. Other options include talking with city planners about incentives for floor areas, building heights and parking requirements.
Manage the downside: Developers should prepare an exit strategy and keep it updated. If they encounter entitlement problems, they must be prepared to sell the property to a third party with local connections and better chances of obtaining approval. The original borrower might sell at a loss, but it is better to lose some money than all of it.
To ease the challenge of obtaining financing, brokers must help developer clients address the issues that concern lenders most: whether a property will be profitable, what it will cost and how borrowers will deal with financial problems. Recognizing and addressing these issues will inspire lender confidence and can lead to an easier underwriting process.
Martin Kulli is a project director at Developers Research, a national real estate consulting firm based in Southern California. The company has completed more than 7,000 assignments in 25 states throughout the country for privately and publicly held companies as well as for local and regional governments. Developers Research is regarded for its proprietary analytical models and methods of evaluating value and risk associated with real estate acquisition, development and disposition.
Please visit www.dev-res.com or call (949) 861-3300.
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