1. Chapter 18 Acquisition, Development, and Construction Financing © OnCourse Learning

2. Chapter 18 Learning Objectives  Understand that a large proportion of the covenants and restrictions contained in loans to finance the acquisition and development of commercial properties are directed at agency problems  Understand those loan provisions that are common to commercial developments  Understand the basic mechanics involved in determining the loan amount and periodic disbursements © OnCourse Learning 2

3. Acquisition – The Land Loan  Acquisition of raw land by two types of investors – the speculator and the developer  Speculator  Has no development plans for the land  Sees an opportunity for price appreciation because of growth constraints, zoning changes, etc.  Developer  May specialize in developing different property types  Has immediate plans for the land  Will proceed as quickly as possible © OnCourse Learning 3

4. Warehousing  Holding of large parcels of properties in advance of the development process by large developers especially those specializing in large residential developments  The developer creates residential developments in a continual process  Financing important as the developer desires to tie up as little equity as possible in large parcels of land 4 © OnCourse Learning

5. Institutional Lenders  Commercial banks and thrifts are main sources of land financing  As local lenders they are in the best position to judge the risk involved a land loan  Land acquisition loans are risky  No operating income  No depreciation of land; few tax benefits  Physical suitability  Cost of preparing land for development may be unexpectedly high  Legal factors (zoning changes)  Loans seldom exceed 50% - 60% of the appraised value of the land © OnCourse Learning 5

6. Institutional Lenders  A financial institution making a loan on a raw land will have a lien on the property as collateral for the loan  Release Provisions – if the land is to be used for residential development, provisions made for release of a portion of the land from the lien of the financial institution  Partial release provision  Provisions that after a significant portion of the development has been sold the value of the remaining land is greater than the remaining amount of indebtedness  Mechanics handled in escrow 6 © OnCourse Learning

7. Seller Accommodation  Seller – another source of land acquisition financing  Seller financing through option financing, seller financing and subdivision trusts  Land purchase option  Loss = option premium if option not exercised  Cost (option premium) based on term of the option, period of exercise, and volatility of land prices  Rolling options  Additional options on more land as existing options are exercised © OnCourse Learning 7

8. Seller Accommodation  Seller financing by seller taking back a note from the buyer  The seller’s note is subject to an increase in risk through the subordination process  Subdivision trusts  The developer puts up only a portion of the sales price and agrees to pay the balance when the property is developed and sold 8 © OnCourse Learning

9. Development  Development steps include:  Zoning  Engineering and surveying  Subdividing  Physical work  Use of land development loan  Obtain government approvals  Subdivision control ordinances  Dollar-based impact fees, including cost recovery fee  Non-dollar-based impact fees - exaction, density bonus, inclusionary zoning, tax increment financing © OnCourse Learning 9

10. Construction Loan  Short-term over construction period  Interest rate is variable and usually over prime  Interest payments are deferred  LTV ratios in the 70 to 80 percent range for commercial projects built for sale, and 60 to 70 percent for speculative projects © OnCourse Learning 10

11. Risks in Construction Lending  Unfinished or partially completed projects  Unknown construction risks such as weather, prices, strikes, etc.  Mechanic’s liens, personal injury, etc.  Permanent lender commitment failure  Failure to meet building codes © OnCourse Learning 11

12. Construction Loan Commitment  A separate agreement whereby the lender makes commitment to make a loan in exchange for a fee  To be enforceable in court the agreement should be as specificas possible and contain no vague language  Terms covered:  Loan amount  Interest rate  Description of collateral  Commitment and details of permanent loan  Developer’s equity at the construction phase  Requirement for securing rental agreements with major tenants  Statement of personal liability in case of default  Statement that the commitment is not assignable to another party 12 © OnCourse Learning

13. Construction Loan Provisions  Reference to the promissory note  Construction procedure details  Loan disbursement details  Designed to insure expeditious construction, within budget and without additional liens © OnCourse Learning 13

14. Construction Loan Administration  Making sure that  Construction proceeds as scheduled  Construction work conforms to specifications  Cost overruns are avoided  No other liens supercede the lender’s  Permanent lender conditions are not violated © OnCourse Learning 14

15. Construction Loan Disbursement  Lender requires that the developer puts some equity into the project  Developer wants to draw funds only as needed  Interest accrues to borrower to the end of the loan  Lender will usually charge a contract rate plus loan fees and points © OnCourse Learning 15