|Land Acquisition Loans Require Special Handling
By Daniel Edrei, Director, Principals Group, MEECORP Capital Markets
Scotsman Guide Commercial Lender Magazine, October 2003
From a traditional lender’s point of view, land acquisition loans are typically very difficult to finance. Without some extensive experience in the field, strong credit, and a proven track record with a given borrower, most institutional lenders are simply unwilling to entertain such loans. They’re just too risky. In the event of a default, a lender may have to wait years to realize the property’s inherent value, while incurring carrying costs and taxes. Due to reams of red tape, regulations and protocol, many conventional lenders can’t afford to wait. It’s simply more prudent for them to reject land loans. Many times, the only financial alternatives for a budding entrepreneur are to take on a partner, forfeiting as much as fifty to seventy five percent of his project, or to seek a bridge loan with a willing specialized private lender. Private money, though expensive, will allow the borrower to retain his equity in its entirety. Private money is patient money. Should a loan go south, a select few private lenders may be willing to wait. These are the lenders to approach if you want to stand a chance in the pursuit of your land loans. But, before you do, it is best to understand what we’re looking for. Without writing a novel on the topic, there are five fundamentals:
1. LOCATION, LOCATION, LOCATION
Perhaps, you expected something original? These are the three most important factors in any real estate transaction. How hot is the market? What’s the market vacancy like? What’s the absorption factor for the intended use of the land? Can tenant retention be expected, if applicable? What demand generators exist within close proximity of the property? How close is it to the central business district (CBD)? The more you know about the location of the proposed transaction, the more likely you’ll land yourself a loan.
The Appraisal Institute defines the term “Market Value” as “the most probable price in terms of money which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently, knowledgably, and assuming the price is not affected by undue stimulus.” Typically, when evaluating an acquisition, we are more concerned with the value of the property than with the purchase price. If you are purchasing at a significant discount, we’re not going to penalize you for negotiating a favorable purchase price. However, bear in mind that the best comparable for a given property is usually the property itself, and it will be up to the appraiser to determine the difference between value and cost. You’ll usually need to tell the lender a good story to explain any significant difference between the two. There are all kinds of value considerations. Normally we are talking about as-is value. Lenders like to finance against the caterpillar rather than the butterfly. However, they may consider the as-improved, as-complete, or sell-out value provided that they can feel secure that it will be achieved. What is the current zoning? Are permits and approvals for development in place? Was there an appraisal done recently? Has a feasibility study been performed?
3. EXIT STRATEGY
How do you plan to pay back the loan? (No fairy tales please!) Do you have construction financing lined up? Presales? Pre-leases? Pre-monitions? This one can be a major factor in determining the cost, loan-to-value ratio (LTV), and overall feasibility of a prospective loan. In some instances, the lender can create an artificial exit via a “put” or a financial instrument to guarantee the loan. Don’t fret; if a clearly defined exit is not forthcoming, there are some properties that merit a little flexibility (refer to item #1).
4. LOAN-TO-VALUE RATIO
Most often, private lenders mitigate the intrinsic risk of a potentially volatile transaction by maintaining a reasonably conservative LTV. As a general rule of thumb, land acquisition loans fall at the 50% mark or lower. However, there are a few exceptions to the rule. Items #1, 2, 3 and 5 usually determine the applicable loan-to-value ratio. Flexibility is always possible if the other factors are exceptional.
5. BORROWER QUALIFICATIONS
Land Acquisition Loans Require Special Handling
This factor is, more often than not, imperative in ascertaining how strict or lenient a private lender is going to be in evaluating the importance of items #1 through #4, the terms, cost and overall viability of a potential loan. Has the borrower been successful in the past on similar ventures? What experience do the principals of the borrowing entity have? What do the borrower/principal’s financials look like? If the borrower will also be the general contractor, is it bondable? Will additional cash or collateral be available if necessary? Keep in mind that these factors are rudimentary basics in evaluating a land transaction. There will always be additional elements to take into consideration, not the least of which will be the lender’s gut feeling about the transaction. Some of the biggest players financing land deals today rely on an indefinable instinct for sniffing out the winners. This characteristic is perhaps the most distinguishable difference between the private lender and more conventional financial institutions.
Daniel Edrei is a Director of the Principals Group at MEECORP CAPITAL MARKETS,
a New Jersey-based commercial real estate lender providing fast, creative funding solutions nationwide. Meecorp specializes in non-conforming transactions such as Bridge loans, Mezzanine/ Equity loans and Sale-Leasebacks (including land and construction), ranging from $1Million to $100Million and above. You can reach Daniel via email at Daniel_Edrei@Meecorp.com or by calling 201-944-9330 ext. 103.
Meecorp Capital Markets By Daniel Edrei, Director, Principals Group,
REPRINTED IN SCOTSMAN GUIDE COMMERCIAL LENDER MAGAZINE OCTOBER 2003