class 3: development financing Flashcards
different phases of development in which Capital will be required
Predevelopment
Land acquisition
Construction
Stabilization
Take-out
Predevelopment
The developer must use his own capital or, in some instances, corporate credit
Generally speaking, why is there no project specific financing available for the predevelopment stage?
Considered too high a risk by most lenders as there is no certainty the project will be executed
some developers will want to delay development in order to do what?
earn a higher promote
requirements so that some lenders be willing to lend for the acquisition of land
Typically low LTV (around 60% or less)
Lenders prefer land that already has services (sewer, water, etc)
Land acquisition loans must usually be repaid at the start of the construction loan
Typically variable rate loans based on Prime or
Bankers’ Acceptance rate
Some land banking loans are also available at lower LTVs (50% or less)
some developers will want to delay the land acquisition stage in order to do what?
to earn a higher promote
Alternatives to traditional loans for land acquisition include
Land purchase option
Vendor take-back
Ground lease: developer leases the land instead of purchasing it
Land purchase option
Low cost means of controlling the land during the feasibility assessment stage
Vendor take-back
Seller finances the buyer by providing a loan
Ground lease: developer leases the land instead of purchasing it
Generally structured as a long-term lease with escalating rent
Avoids large initial outlay of funds
Buildings usually revert to landowner at the end of the lease
Lenders rely heavily on the developer’s what in the construction phase?
on the developer’s credit-worthiness and the level of equity investment by both the developer and any equity partner
Equity capital must be injected into the project before the first draw
Often require a certain level of pre-sales or pre-leasing
Market players in the construction phase include
Commercial banks
Pension funds
Private investors
Amount of construction loan will be based on what?
Amount will be based on total expected cost and anticipated value at stabilization
LTC of 65% or less
LTV of 75% or less
Can include or exclude land values depending on project
Typically, variable rate loans based on Prime or Bankers’ Acceptance rate
Prime or Bankers’ Acceptance rate
Interest is capitalized and increases the principal amount outstanding.
how is the loan provided in a construction phase?
Amounts are advanced (called draws) as the project advances
Often include developer soft costs
what is the max amount of time that construction loans can extend to?
can extend to the period of time it takes to lease-up a property and stabilize its cash flows
how are construction loans generally repaid?
Construction loans are generally repaid from the proceeds of sale of the property or from the proceeds of a term loan (the loan of buying the property yourself once it is fully built and ready to be used for renting)
what must be injected before the construction loan can be drawn down?
equity
they won’t give any loan amount until after some time
what is sometimes included in the construction loan for the stabilization period?
for which type of properties?
Funding for carrying (interest) and operational costs
Multifamily
Condos
a mini-perm
Bridge financing arranged if property has not reached its stabilized NOI
Typically floating interest rate loan
when is take-out financing arranged?
Once the property has reached its stabilized NOI, or has been delivered to the tenants
The take-out financing is sometimes arranged before the construction financing (Can be required by the construction lender)
take-out financing
Reimburses the construction loan
Typically a mortgage loan
Can be fixed or floating rate
Term of 15 years or less
Amortization of 25 years or less
investors’ relationship with Equity Return
Most investors eventually move beyond valuation based on a single year’s income to consideration of the rate of return over the expected holding period
When evaluating prospective rates of return among investment alternatives, most investors start with the rate of return on Government of Canada Bonds as the baseline.
Investors add a risk premium to this “risk-free” rate.
how to find the expected return of a particular investor?
The total of the GOC bond rate and risk premium
yield curve explained
GOC rates are normally lower for shorter-terms than longer-terms
This relationship between rates and maturity is represented in the “yield curve.”
The main financial metrics used in development for decision making by equity investors and it’s purpose
Internal Rate of Return (IRR)
This metric uses the cash flow of the property or project
Internal Rate of Return (IRR)
This metric uses the cash flow of the property or project
the rate of return of the investment
It is the discount rate which will give an NPV of zero
The IRR is compared to the investor’s hurdle rate (required rate of return)
If IRR > Hurdle rate: investment is made
The greater the IRR the more attractive the investment.
the most widely used investment metric in real estate.
IRR
In Development three IRR calculations are often made, depending on the investment strategy.
Which ones?
The Development IRR
The Holding IRR
The Total IRR
The Development IRR
calculates the return for the initial investment, through the construction and stabilization periods
The Holding IRR
calculates the return for the period the asset is held, after the stabilization period
The Total IRR
calculates the return for all the above periods combined
i.e., from the initial investment to the sale of the asset
Preferred returns
when an investor has first claim on profits (or a specified distribution formula) until he has achieved a certain target IRR
Often given as an incentive for a financial partner to invest
Promote
when an investor earns a disproportionate share of the profits
Often given to the investment manager or operating partner as a form of bonus for achieving a higher IRR
Generally applies to profits after the financial partner has achieved his targeted IRR
Clawback
when an investor gives up a portion of his return to another investor if a certain IRR is not met
Applies most often to the operating partner or investment manager
