Commercial Notes: Why construction lenders’ appetites fluctuate
Q: Why is project development financing becoming more expensive and difficult to secure, often requiring a higher equity contribution?
A: Construction lenders for a variety of reasons are looking at development projects with more scrutiny. Construction lenders are portfolio lenders, and they are constantly evaluating the borrower, product and geographical concentrations within the loan portfolio in order to manage portfolio risk. No lender wants to have too great a concentration of any one product type and/or a predominant geographical presence within its loan portfolio.
Couple those concerns with individual borrower lending limits, whether legal or self-imposed, and construction lenders will continually have varying degrees of appetite for financing development projects.
Applying the example of New Hampshire’s heated for-sale housing market, some construction lenders feel that the pricing appreciation has peaked, absorption has slowed, and there are too many projects that compete for the qualified purchaser. If such a lender has a strong portfolio concentration in subdivision and condominium projects and has now concluded that the market demand is waning and prices are weakening, their appetite for subdivision and condominium projects will be diminished.
This reduced appetite has nothing to do with your project or your capabilities necessarily, but is an internal decision to reduce new loan exposure in this product type until market conditions as they perceive them or portfolio concentrations change. I know of a recent situation in which a construction lender provided a loan for a project that is performing well below projections, and that lender has concluded that they will make no additional loans in that geographical market no matter what product type or loan structure because of their perceived risk from this project.
Situations like this will likely make a lender’s terms less competitive and cause further scrutiny toward the funding request. Often a construction lender will still offer to finance a project even with perceived portfolio risks, but will reduce leverage or increase profitability to compensate for the perceived risk.
Developers need to realize that requesting loans from multiple lending sources will eliminate a singular interpretation of your project’s funding acceptance. The good news is that there is abundant capital available from lending sources that specialize in construction loans for well-structured projects. My firm has secured funding for a number of development projects in northern New England with both regional and national lenders that have no presence in the market except as a lender for development projects. These lenders typically have no portfolio concentration in this market and are actually seeking portfolio geographical diversification by lending into the market.
Remember, construction lenders are not your partners and their perspective is very objective in evaluating the merits of a development loan request. Construction lenders do not live the emotional roller coaster ride through the permitting process that the developer does and are only seeking a profitable loan structure for their capital.
Providing supportable market documentation for pricing, absorption and project costs along with a successful track record will always attract competitive development financing. nhbr
David B. Eaton, president of Eaton Partners, Manchester, manages the firm’s Commercial Mortgage Group. Questions can be submitted to him at Commercialnotes@ eatonpartners.com.