Many
investors
are unfamiliar with development loans, but they're a crucial tool in
the real estate game and can represent a lucrative investment
vehicle. Development loans are short-term loans that allow a
developer to prepare a site for future construction. Funds are used
for site work such as grading, utility installation, and basic
infrastructure such as streets and lighting. Development loans are
generally paid off quickly from the sale of lots to new property
owners or builders.
In order to properly underwrite a development loan and control risk, a number of important factors have to be addressed:
Borrower's Equity: Through initial investment of cash or the pledge of other unencumbered real estate, the borrower partially funds the project so that the Loan-to-Value (LTV) of the property being developed is within a prudent range. Most commercial banks require 30%–35% down. This equity protects the lender and investor as a cushion if the borrower fails to perform, allowing for full repayment of the loan with a discounted sale of the property.
Management Track Record: A review of the borrower's prior track record is important to determine their level of experience and success in identifying attractive development projects, and managing them to a profitable conclusion. Prior experience, while not indicative of future performance, certainly provides a level of confidence that the project will succeed and the loan repaid as agreed.
Market Dynamics: Lenders need to pay close attention to trends in the marketplace. It's important to understand the demand for the type of site being developed, and also what competing properties are, or likely will be developed during the life cycle of the project being considered.
Takeout Timing: The loan structure must include a reasonable pay down schedule based on the likely sales timing and price of the developed lots to be sold. Most developers want to keep their profit up front, therefore it's crucial that the lender negotiates for the proceeds of each lot sale to be applied to a repayment schedule that is in every party’s best interests. For example, an accelerated repayment structure ensures that the LTV stays in the lender's and investor's favor as lots are sold, leaving most of the developer’s profit to the end of the project.
Commercial banks are a typical source for development financing, but there are numerous important private alternatives. These can be valuable for developers and can also provide an excellent investment vehicle for private investors. Since the financial crisis of 2008, many banks have either exited the development lending space altogether or significantly tightened credit standards. This fact has left many developers with limited financing options, and a very slow and laborious process for obtaining financing. Private development loans from experienced non-bank private lenders are an increasingly attractive alternative. These firms are specialists, and can bring their narrow focus and expertise to the table to provide quick and efficient loan approval, streamlined loan documentation, and prompt closing to the developer.
Private lenders create investor opportunities as well. Private lending firms often fund their loans by working directly with individual investors and share a large portion of the loan's interest revenue with them. Compared to the anemic interest paid to depositors by banks, the returns can be highly attractive. Development loans in particular can be extremely lucrative with an elevated Return on Investment (ROI) and quick payback due to the short-term nature of the underlying loans.
Both developers and investors should conduct their own due diligence as they consider alternatives to meet their financial goals. While traditional commercial banks remain one alternative, savvy developers and investors should research private lending alternatives as another viable outlet.
William
“Tripp” Nassour III is a Managing
Director of United Security Investors (USI). Creating
value amongst all stakeholders has been a hallmark of USI’s success
within the private lending arena. As one
of Beverly Hill’s prominent bridge lenders, providing liquidity for
owners of both commercial and residential real estate assets, USI has
developed a particularly strong track record by engineering
value-added financial solutions for borrowers with whom the company
has enjoyed a longstanding relationship. The
USI team prides itself on repeat lending opportunities from its
borrower clientele by providing the agility and responsiveness that
its borrowers have become accustomed to.
Additionally, USI’s investor base has enjoyed an unparalleled 58
consecutive months of positive returns since the company’s
inception in 2011. This impressive track
record can largely be attributable to USI’s vast local knowledge
and experience of the areas in which it lends, paired with the
impeccable financial acumen of its principals who boast more than 45
combined years of experience in the real estate industry
