Complicated diagram, right? Nobody ever said commercial real estate development financing was a breeze for anyone who isn’t a billionaire real estate developer. This is what we have come to for developers seeking commercial real estate development financing in today’s regulatory setting. The capital markets have been shaken by the change in interest rates by the Fed and that means the investment preferences of the capital markets are going to change – and we are not just talking about interest rates. While I have read many white papers and seen research that suggests there is no causal relationship between changes in capitalization rates when interest rates change, we all recognize that negative debt leverage isn’t going to be a sustainable proposition in the capital markets. What these changes do mean to the average promoter or commercial real estate development financing sponsor is a greater share of the profits will be lost to third-party capital and the standards for underwriting will tighten even further.
In the end, every transaction has to stand on its own two feet and provide clear demonstration via independent documentation as to the following issues (or the answer will be a rejection):
- The potential opportunity to obtain the stated economic outcome; then
- The ability to manage execution risk.
It’s as simple as that. 99% of business plans will definitely demonstrate the opportunity – though it happens usually without any supporting third-party evidence. Having said, 99% of business plans routinely fail to demonstrate how execution risk will be managed. If you are seeking funding you have to realize that default risk underwriting reviews focus on execution risk and a failure to achieve this important goal will always result in a rejection.