Construction Lending: Obstacles that can impede a construction project

Construction Lending: Obstacles that can impede a construction project


Our LA office sat down with Bradley Ross, Vice President at Madison Realty Capital, and Justin Thompson, Managing Partner at Nixon Peabody, to discuss the construction lending market and obstacles that may hold up borrowers from completing their construction projects. Continue reading below to see a list of the major takeaways that we had during our discussion:

  • Loan Balancing: Loan balancing involves managing the capital stack with the total cost of the project. This is more difficult than it seems because the initial estimate cost of the project can vary between borrower and lender. To further understand this concept, Justin Thompson during our discussion stated, “A point of focus on a construction loan that is unique and fraught with pitfalls is loan balancing. We want to make sure that there is there enough money between the equity and debt to complete the project because otherwise, one would be underwater from a lending perspective and that involves making sure you got the budget from the borrower and understand where they are in the development process, tied down what equity they’ve got in the process, and what the other collateral sources are.”
  • High Volatility Commercial Real Estate Capital (HVCRE): This term is given to commercial real estate loans to be riskier than other types of commercial loans. An HVCRE loan is any loan used for acquisition, development or construction real estate. A borrower must contribute a minimum of 15% of the total cost of the development for the bank to recognize the underlying land value.
  • Borrower/Developer Experience: It is important that the developer not only has experience in developing similar type assets but within similar markets as well. An example from our discussion was that it’s not favorable to have a developer from St. Louis who predominantly develops offices to come to San Francisco and develop apartments.
  • Land Leases: In contrast to themselves developing on their land, owners have the option to lease their land which removes the responsibilities and risks that would normally come along with a construction project.
  • Factors that affect construction lending in California:
    • California is a single-action state and It is important for borrowers to understand what constitutes an action.
    • Carve-outs are difficult to pursue in the event of a default. A carve-out guarantee gives a commercial lender the authority to go after a borrower’s personal assets if the lender forecloses on the property.
    • One of the most scrutinized areas that you’ll get on a loan negotiation for documentation is what should be constituted as a carve-out. (waste, fraud, misappropriation of funds, etc.)
  • Suit of Completion: Lenders will file this document in the event of default on a construction loan. This means they want the construction project completed; at which time they will hand the bill to the borrower who originally defaulted on the loan. The lender typically does not pursue further.
  • Date Downs (during the Title Process): Increases the amount of title insurance coverage as the total amount disbursed by the lender goes up. This means that as the loan continues to draw, the coverage will go up. Its initial coverage will not begin at a full amount of the total loan.
  • Hotel Developments: When working with hotel developments, a borrower would need to assure that a hotel franchise flag can be subordinated. There are special requirements that differing hotel franchises require that, if not met, can cause the borrower to lose the parent franchise flag. This is problematic because your value at completion would be significantly lower without that flag in place.



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