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