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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   November 2009

5 Components of a Successful Exit Strategy

Want to speed up a deal? Trydrafting a compelling proposal

Just a few years ago, commercial property-developers only had to submit a well-thought-out proposal for virtually any type of income-producing property, and they would receive nearly instant financial support. Today, the lending landscape is the complete opposite. Even the most-successful and established developers are finding it nearly impossible to secure funding for their projects.

In today's market, the most effective course of action for developers seeking financing is to have a powerful exit strategy. This often is the most difficult and demanding aspect of a project presentation, but it also is the most crucial segment of a financial proposal.

By working with a commercial mortgage broker who understands how to help craft powerful exit strategies, developers often can realize greater success finding funding. In fact, in today's environment, projects that are presented without strong, viable and achievable exit strategies often are shunned within seconds.

Commercial mortgage brokers can help their clients avoid this by understanding what is required to address lenders' primary concern: loan repayment. A great starting point is to become familiar with the five rules of thumb for a strong exit strategy. Keep in mind that each component depends upon the successful accomplishment of the preceding requirement.

1. Developers must have cash equity in their own projects. Your clients must have either a 30-percent loan-to-cost ratio or 20 percent to 35 percent of the project's value in the form of hard cash. This calculation does not include equity in the land associated with the property. Rather, it is limited to actual cash expenditures into the project phase for which funding is sought. When this cash infusion is absent, it raises the question of the principals' belief in their own project: If they are unwilling or unable to risk investing in their own project, then why should anyone else?

2. Infrastructure completion is a necessity and depends on the developer's cash infusion. Often, the cash that the developer contributes will cover the costs of completing suitable infrastructure. Potential tenants often will find it difficult, if not impossible, to make firm commitments to locate their businesses or establish residences on the property before the infrastructure is in place. In other words, the lack of infrastructure will make presales and preleasing impossible.

3. Presales and preleasing facts and figures are essential. Commercial borrowers today need more than good credit scores and projections that their projects will sell after they are completed or that banks will provide construction loans or permanent financing. Lenders now require verifiable proof of the principals' ability to cover their monthly debt service. Examples of this include: interest reserves, presales contracts with nonrefundable deposits, preleasing agreements in writing from reputable companies and funds deposited into escrow accounts. There also are similar requirements for showing the project's ability to repay the principal at the end of the loan term. Major contracts for sale of primary portions of projects, corporate partnership arrangements, or project buyouts and ownership-transfer packages may provide tremendous lump-sum payments. These takeout funds must be available and verifiable; their sources cannot be speculative.

4. Developers should investigate and take advantage of available tax incentives. Federal, state and local governments offer myriad tax benefits to commercial real estate developers. Depending on each individual project, these benefits may yield short-term or long-term savings, abatements, rebates, payment reductions and other financial advantages. In many cases, these benefits can be assigned directly to lenders to repay or offset a portion of debt-service, and payments can begin immediately following the project's funding. There may also be the possibility of lump-sum payments to repay loan principal upon construction completion. In any event, including direct or indirect payment of funds from these sources will strengthen an exit strategy.

5. Loan guarantees from verifiable, reputable institutions can be used, especially for green-building projects. There are several institutional funding sources that will commit to issuing unconditional guarantees for all or portions of bridge loans that have been provided to qualifying projects. The fact that these guarantees apply in some circumstances, however, does not circumvent the need for the particular project to provide adequate exit strategies for the project segments that the guarantees will not cover.

Commercial mortgage brokers should help their clients address each of these five considerations adequately. An exit strategy that covers these areas will be ironclad and will result in a greater probability for a successful funding. The loan-repayment process also will more likely proceed smoothly, and the project's cash-flow requirements should be readily provided because their sources were designed into the project from the beginning.

Brokers who wish to remain successful must now think and work like true real estate financial analysts. This shifting paradigm should provide our industry with a safety net that will prevent financial debacles such as the one we are living through from occurring again. 


 


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