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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   November 2006

How to Solve the Condo Conundrum

As condo building continues, while funding decreases, private loans arise as funding solution

With the condominium market in flux, private bridge and mezzanine lenders are seeing a rapid increase in the business of financing prudently structured projects. Brokers seeking funding for condo projects should seek bridge and mezzanine lenders with the know-how and patience to be comfortable taking on additional risk.

It’s little secret that the condo market has seen ups and downs. In recent years, low interest rates made it more feasible for renters to own condominiums. With merely a small deposit, people could own units that allowed them to pay mortgages that were comparable to market rent prices.

Sales mushroomed. Lenders fought to meet the growing demand, or to garner business from the demand. They raised loan-to-value ratios, sometimes beyond 100 percent.

Today, rising interest rates are impacting consumer appetite for condominiums and creating major concerns for owners and developers. Further, many existing condominium-owners with variable-rate mortgages are hit with larger mortgage payments than they expected.

Some condo developers have reported cancellations as great as 60 percent. In some cases, condo-investors have switched back to renting their units.

Many markets that had substantial condo construction and conversion now have more products competing for a shrinking demand. In Miami-Dade County, for example, more than 25,000 condos are under construction, according to Torto Wheaton Research. In the same market, single-family and condo sales decreased 33 percent between June 2005 and 2006, according to the National Association of Realtors.  

Traditional lenders view condo-construction and -conversion projects, especially the bigger-ticket ones, as the most likely to go under if the economy tanks. So loan-to-value ratios for these projects are now becoming more conservative, and presale requirements more pertinent. Further, interest reserves and prepayments have escalated.

Even the best borrowers with the most extensive experience and a proven track record are having difficulty finding the leverage they need. Those on descending rungs of the ladder are being shut out. Some traditional lenders have stopped financing condominium-construction and -conversion developments altogether in riskier markets.

In the absence of traditional loans, private bridge and mezzanine loans can be a good option for borrowers. These lenders often view condominium development and conversion as definitive opportunities. After all, with senior-debt leverage decreasing, developers are increasing the equity in their projects. That means they have more invested in the deal and proportionately more commitment.

Private lenders want to know that their investment is secure. Should conditions go awry between a project’s construction and sale, lenders would prefer it be the borrower who has trouble sleeping at night. That said, however, lenders can restore confidence in the shortfall or absence of traditional debt and add substantial leverage to transactions.

Private lenders realize that the overall upside of a project may require patience. They know they will recoup their investment if the product is strong, if there are comfortable margins proportionate to risk and if the market is stable. Traditionally, this method involves the lender’s willingness to own the property from the onset.

Unlike banks and institutions that work on thin spreads and have to answer to stockholders, private lenders can afford to wait out a temporary lull in the economy. They do not have to write off a loss, should there be a foreclosure. Sometimes, a foreclosure can result in an “unfortunate success.” Although few lenders look to finance a project they may end up owning, they must consider the possibility in evaluating a transaction, especially in a transitional economy.

Borrowers seeking condominium-project financing can benefit from the speed of private bridge and mezzanine loans. By design, private bridge and mezzanine lenders can move faster than traditional institutional lenders.

With bridge loans, borrowers can often start shoveling while they work on buttoning up their construction financing. With mezzanine loans, lenders often underwrite using the bulk of the senior lender’s underwriting components. This ensures there is no duplication of the due-diligence process.

Although real estate investment trusts and major private developers are active players in the condo market, small private investment partnerships and family-operated real estate companies also develop many projects.

Ultimately, private lenders are a good option to work on transactions that may fall out of fashion with the rest of the lending community. 


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