New Construction Financing Valuation Failures

Your Deal Wasn’t Priced in Line With the Capital Markets

Knowledge of the investment preferences of the capital markets (i.e.: business intelligence analytics) is a must-have, lest you risk getting your funding kicked because you priced it based upon specious assumptions.

Commercial real estate new construction financing is very much dependent upon the exit value of the future property’s net cash flow. Valuation of the resulting securities and the financing the project can be reasonably expected to support today are considerations that often lead to the unintentional failure of developers to obtain financing.

Check Your Work – Do Your Due Diligence

The most important considerations in pricing out the financing for a new construction CRE project include:

  • Cap Rates. Remember, the “going-in” cap rate is what counts and not the market cap rate you are assuming you can apply to your project as cost of issuance isn’t reflected in most market data. This is a very common error that leads to automatic rejection.
  • Discount Rates. Don’t fool yourself. The discount rate on the future value is the IRR you have to pay on your capital for the current raise and not some arbitrary number. That IRR is the cost of capital, assuming the cap rate for the vertical leads to stupid over-valuation and instant rejection.
  • Loan Yield. This is the metric to focus on if you insist on using debt leverage to fund your project. Loan yield is equal to stabilized Net Cash Flow divided by total project budget going in.
  • Issuance Costs. Don’t guess about issuance costs – know them. If you make assumptions based upon preference you only make the underwriter want to dig deeper – a battle you will NEVER WIN.
  • Working Capital. The biggest sin in valuation is underestimating the working capital requirement in order to make the cap rate work. This will get you nothing but a rejection.

Chances Are You Don’t Do Capital Financing Every Day

Consider getting someone who does this sort of thing every day to help you. You cannot afford to blow out a single source. No matter how specious they may seem, every single prospect has the potential to be the one you needed. Get the help and increase the odds of getting the financing. Don’t get the help and you can keep reading stuff like this and starve.

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