Digging Deep - Lengthy planning and zoning processes force developers to search for pre-construction financing.
By Brad Berton
When Scott Brenner looked at the 17.2-acre site in Coral Springs, Fla., he envisioned a grocery-anchored retail center—not the high-density residential site for which the land had been zoned. He was eager to hammer out a deal with the landowner, WCI Communities, but the financially strapped homebuilding firm didn’t want to negotiate a purchase option.
To move on the opportunity, Brenner, who is the CEO of Brenner Real Estate Group, had to buy the site and then pursue the amended zoning. So he obtained a $9.45 million “acquisition and re-entitlement” loan from Chicago-based specialty real estate finance firm Wrightwood Capital.
Securing such pre-development loans usually entails finding an opportunity-minded real estate lender that understands the property’s potential, says Brenner and his mortgage banker Paula Ingram, a director with Chicago-based Cohen Financial, who arranged the financing.
Like Brenner, many developers come across opportunities that require extensive pre-construction activities such as rezoning. For various reasons, they may need to acquire a property before they’re ready or able to seek a traditional construction loan covering most of the development cost (including the land purchase).
For such projects, developers have an alternative form of financing—land loans. These financing structures are quite useful for developers who face lengthy pre-construction timetables that include rezoning approvals or infrastructure installation.
FINDING THE MONEY
Most traditional construction and permanent lenders tend to steer clear of land loans. But there are still options in the marketplace for seasoned developers who can’t find the up-front cash needed to buy and prepare a promising site before the construction loan kicks in.
Various specialty lenders and opportunity-minded fund managers—even some commercial banks—offer pre-development financing fitting their particular underwriting parameters, says Brad Sevier, president of commercial real estate finance firm Highland Realty Capital in El Segundo, Calif.
Those parameters usually pertain to the quality of the borrower and the real estate, according to Sevier and other finance pros. These lenders focus on a few key characteristics: a strategic location in a fundamentally sound market; the developer’s relevant experience; and whether a borrower’s balance sheet is sufficient to carry the project if the exit timeline drags out. Such delays can happen if project approvals take much longer than expected or a last-minute engineering or environmental issue delays vertical construction.
When it comes to these loans, developers need to bring hard cash to the table and personally guarantee repayment in full should the plan sour and the collateral fail to cover the loan balance. Still, while loan pricing varies widely in today’s topsy-turvy capital markets, pre-development lenders aren’t quoting interest-rate spreads anywhere near as wide as the hard-money lenders known for quick closes and sticker-shock rates.
Today’s sophisticated lenders quote floating-rate land-loan spreads in the range of 325 to 475 basis points over the LIBOR index, the widely used benchmark for short-term rates. Given where LIBOR has fallen since the Federal Reserve cut short-term rates in late January, a quote at 400 over the index would leave the going-in coupon rate at slightly more than 7 percent, as of press time.
Highland Realty Capital, for example, is helping a land developer client pursue a second round of pre-development financing for an 84-acre site in Southern California’s Inland Empire, to house a mix of retail and commercial space, a hotel, apartments, and for-sale housing. Th e firm had previously helped the developer secure a loan covering 50 percent of the land purchase cost, after which the client invested additional cash equity to obtain all the necessary entitlements.
Sevier says he expects to secure for the developer another loan for $33 million, which will cover about 83 percent of pre-construction costs, including the land purchase. The anticipated rate will fall in the vicinity of 350 basis points over the LIBOR. Sevier is working with specialty lenders that understand the loan amount will equate to a 50 percent loan-to-value ratio once another $15 million or so in additional near-term infrastructure development is completed (some of which a local agency will reimburse through bond financing).
In this situation, Sevier says lenders are more comfortable assuming that risk since the developer has pre-sold the apartment site to a national developer and also negotiated pre-sales for a couple of the retail pads. “This demonstrates demand for the end product,” Sevier says. It also gives potential lenders an estimate of the property’s future value at a time when they’re trying to minimize risk.
LEVERAGING PARTNERS
Under the right circumstances, specialty lenders might provide as much as 90 percent of the capital required to purchase a property and prepare it for development, explains Paul Braungart, president of Marlton, N.J.-based Regional Capital Group, a private lender and investor specializing in short-term financing, including land loans.
For instance, Brenner’s loan funds about 85 percent of the costs he expects to incur before seeking construction financing or flipping the WCI Communities site. That includes the reported $7.5 million site-purchase price and ongoing pre-development functions, including the re-entitlement process, which Brenner believes will lead to the approval of an approximately 141,000-square-foot retail center. He declined to specify the interest rate on the full-recourse loan, but a published report says it floats at 335 basis points over LIBOR.
In addition to experience, pre-sale agreements can help developers lock down land loans. Consider developer Andy Miller: The principal of Phoenix-based Vested Housing Group knew it would take months to secure the rezoning that would allow for high-density apartment development on acreage designated for industrial use in suburban Las Vegas.
Last year Miller inked a pre-sale arrangement with Principal Real Estate Investors at a price tied to the 350-unit apartment project’s appraised value at stabilization. Principal was willing to take on some of Vested’s development risk to get a slightly better yield when it purchases the completed property, and Miller used Principal’s balance sheet to secure a land loan to take down the site while pursuing the zoning change.
Miller subsequently formed a venture with Principal to develop Henderson Lofts; the venture borrowed $13.1 million on a short-term basis from Wachovia Bank to finance the $10.5 million acquisition of the 16.25-acre site, along with ongoing entitlement activities.
The pre-sale deal will likely not provide the entrepreneurial developer with “optimal profitability,” Miller acknowledges. Nor will it eliminate all the market and development risk, for that matter. But a pre-sale arrangement can work well for local and regional developers that lack deep pockets, he says.
“Even if you buy a site with the right zoning, it still might take six to 12 months before you get final approvals,” Miller notes. “Most local and regional developers just aren’t set up to ‘land bank’ like that.”
[ the points ]
The Long Haul
Securing land loans requires solid experience. These three points will help you secure the financing needed to get through pre-construction.
■ Sell your strong points. Lenders are looking for solid sites, a breadth of experience, and financially sound balance sheets. Address these areas with your financial partner.
■ Get your post-development plan in order. Many lenders will feel more comfortable with pre-development risk if a site is already pre-sold to another developer or commercial tenants have already given their commitments.
■ Have a clear vision. If your plans include, for example, a rezoning process, explain your vision to your
lender. They need to understand the challenges and timeline you face to achieve your development dream.
