The Basel III accord seems to have had the intent of making CRE new construction lending more problematic in the United States, thus supervised institutions have less of an appetite for ADC loans due to the requirements for higher loan loss reserve contributions that higher LTV loans require. The practical impact of Basel III is to reduce the access to capital in the most important segment of the U.S. (or any other) economy. This will have the predictable result of reduced indirect economic impact that places a drag on GDP growth and create the opportunity for bridge and mezzanine lenders to further penetrate the CRE market on both the acquisition side and the ADC lending side. This is definitely a trend CRE developers, promoters and securities private placement offering issuers should start paying attention to regarding their own opportunities.
Time is money. We all know that CRE deals come with a built-in self-destruct mechanism in the form of the feasibility period commonly associated with every real property acquisition agreement. The promoter has to get enough due diligence completed to justify the contract going hard or closing on the land or exit the deal and eat a capital loss. Historically, mezzanine and bridge lending has been largely ignored due to the higher interest rates associated with these funding products. While it is true these funding products cost more, a closer look may reveal that cost may in fact be negligible compared to the cost to capital associated with a lost opportunity.
Every CRE development deal requires the production of due diligence documentation to support the representation of material facts the promoter will make in their business plan. The minimum set includes:
- Environmental Phase I.
- Permitting & Zoning Legal Review.
- Valuation Analysis.
- Project Feasibility Study.
- Schematic Phase Architectural Design & Outline Construction Specifications.
- Construction Value Engineering Report.
- Specialty Consultant Services.
- Conditional Construction Contract (GMP).
- Business Plan of Operations.
- Site Control (Purchase & Sale, Option Agreement or LOI).
- Survey (Metes & Bounds and Topo).
- Site Plan & Development Plat.
Excluding the funds placed in escrow for the site control agreement, the bill can easily hit $100,000 or more for the promoter’s at-risk capital. On average, 3 out of 5 deals are not going to cross the finish line, so the bill is really $300,000 and that means the gain has to be at least $600,000. Those numbers suggest the transaction value has to top $10 million to make the numbers really work for the promoter. If the odds of failure were to be reduced to 2 out of 5, then the numbers start to get a lot more attractive and that is where the bridge and mezzanine lenders can play a crucial role. They close fast, they do offer lower loan-to-value ratios in most circumstances (talk to us about how that can be changed or otherwise addressed) and provide a key role in the transaction as far as the ADC financing is concerned. On a $10 million project, the cost to capital would not be expected to be materially-significant to the overall business deal due to the higher level of assurance of outcome and the potential end value of the project when it is refinanced on completion of ADC activities. Take a minute and think about this, do some numbers and you will see for yourself the mezzanine and bridge lenders are going to be the promoter’s newfound best friends.
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