Along the coast of Southern California there are dozens of incomplete or undeveloped properties that seem based on location to have innumerate possibilities of a very profitable future. A number of my close associates and friends have been successful real estate developers in the Western United States for decades and have continue to express to me their frustrations in obtaining project funding. Mitch, a developer in Newport Beach said,” I went from receiving 70 to 90% of the cost of construction on an apartment complex at 5 to 8% interest per year throughout the 90s and early 2000s to getting offers of 20 to 30% loan to cost financing since mid 2007.” The restriction on banks to lend based on poor decisions and a “ask and you shall receive lending” attitude through 2006 has now left this economy in a state where even the most deserving projects are being turned down.
Many of these projects would fill a much needed gap in the construction employment section creating thousands of construction jobs. I sat down with the Vice President of Lending for a very reputable private mortgage fund in Irvine, California; Pacific Investment Management Fund to ask him directly what type of projects they are funding. The private lending world, many times known as “hard money lenders” are attempting to bridge the gap in institution financing that has been created by the frozen credit markets. In my two hour long conversation with Mr. Joseph as we sat at Pacific Investment’s mahogany conference table overlooking Newport Beach’s backbay he outlined the following guidelines or tips for anyone looking to obtain financing for their development or real estate project.
8 Tips from Pacific Investment Management Fund’s Vice President of Lending Brian Joseph:
- Presentation is a very important step. Take a few days and prepare a concise well organized executive summary. Make sure to paint the overall picture of the project and why this particular project is needed in a crowded real estate market. It is important to separate yourself from the pack this can be accomplish in a well organized and neatly presented packet.
- Seek the advice of a CPA or Accountant to help in the preparation of pro-formas and/or existing financial performance. Include these specific ratios for any commercial project: Debt Service Coverage Ratio, Return on Investment, Break Even Point, and Vacancy factors using the low industry standard.
- Have an appraisal based on a conservative approach. Too many appraisals are done for the retail client rather than the wholesale lender. An inflated value kills more projects than any other factor. Developers should advise their real estate appraiser to bring the value in for a wholesale client. This will allow the developer to see true profit margins and adjust cost factors.
- If you are seeking greater than a 65% loan amount based on the future value of the project and the client does not have the other 35% cash on hand bring in a partner prior to trying to obtain financing. “Skin the game” is extremely important, lenders like to see that the client is willing to partake in the risk with the lender. With the client usually taking the lion’s share of the profits it is important to ensure they are willing to take equal part in the risk of the project.
- Do not try and obtain financing as a rookie, it is nearly impossible to attain financing if this is your first project in this particular industry. For example if you are trying to build a flagged hotel and your background is in residential construction, bring on a flagged hotel advisor prior to seeking financing.
- Be realistic in your ratios. Plan on an annual interest expense based on a 8-12% interest rate if you are outside the conventional lending arena. Do not have your proformas based on a 6 or 7% interest rate if you are seeking private funding. Many clients’ projects are profitable at 6 or 7% but debt service ratios are well below 1.00 at the cost of money in the private lending world.
- The single most important factor in obtaining funding for your development is your Exit Strategy. This is how and when the lender will be repaid. Do not submit a loan request that state the exit strategy is to obtain conventional financing. In many cases lenders funded projects with that single exit and are now stuck with undervalued or non performing properties. Provide three or four different options to pay off the lender at the end of the terms. Investigate USDA, HUD and other Federal loan options as well as different sales strategies to unload the completed project. For example, if you are attempting to build a condominium complex investigate the following exit strategies: (a) conventional financing and the exact current lending parameters that have to be met (b) turning the complex into section 8 HUD housing and what grants are available (c) leasing the complex out as rentals and what the debt coverage ratio would be (d) selling off the individual units and the exact absorption rate that will be needed to liquidate all the properties prior to the note ballooning (e) upgrading the development to be used as an assisted living center/nursing home.
- If your project is turned down by conventional banks make sure that your project’s business plan has covered each of the points above specifically. If your lending needs cannot be met by your local bank or credit union trying submitting your loan to the dozens of private mortgage funds like Pacific Investment Management Fund or Redwood Mortgage in California. Many projects are left unfunded due to the lack of effort and preparation developers and investors are now required to perform prior to seeking financing.
(via Ezinearticles.com)