Commercial Real Estate Development Deals – Avoid the Pitfalls
Many fortunes have been made and lost in the world of real estate. The real estate bust of 2008 caused many to lose everything. Is it now time to begin re-investing in commercial real estate development? Certainly the real estate world is due for a pendulum shift, and if you start to examine your opportunities now, you’ll be ready to profit when the upswing occurs and also be able to save time in weeding out deals that don’t have a chance for successful funding.
Before you decide to take these requests on as a broker specializing in commercial finance, take these notes into consideration.
1. Pay close attention to the resumes and experience of the principals in the development group. Working with experienced developers is essential in ensuring your deal will have the best chance for approval with lenders. What is the track record of group executives and what is their reputation for fielding successful projects. Can they prove past projects are completed on time and on budget?
2. Measure the liquidity of the principals. Very often, a commercial finance broker will see requests to fund developments but the sponsors or principles of the project have no money. The likelihood of funding a deal where the principle that has $20,000 cash or a net worth of $100,000 that wants $7,000,000 in financing is next to zero. The principles need to have the appropriate net worth or liquidity behind them compared to the loan amount they are requesting. Also they need to have enough equity in their project for any lender to consider financing them. We call it having some, “skin in the game.”
3. Consider how the project interacts with its community. If a project doesn’t fit with its geography, or make sense demographically, it’s probably not a wise investment for a lender. Retail stores especially need to be able to draw tenants with large customer followings. Ask developers for valid projections of revenues based on the market it serves.
4. Examine the ability for projects to see early returns. In a multi-tenant situation, ensure that presales of units (such as condos, etc.) are moving quickly and momentum is building around the project. Besides ensuring returns for a potential lender, high levels of presales tend to create a “buzz” around the property to a lender. Presales insure the lender that positive cash flow can be reached quickly to meet the lenders debt service requirements for a loan. Borrowers who are developing a retail center should present you with signed leases from retailers. Having locked-in tenants on a retail center is a good sign of a project’s success.
5. Understand the exit strategy. This is one of the biggest questions that brokers fail to ask their client in development projects. Lenders and investors want to know how they will be repaid. The borrower needs to provide a sound plan detailing its tactics to drive business and sales and ensure the lender/investor’s re-payment of the loan. Firm targets and projections should be included in the exit strategy that makes a broker’s job easier in determining lender risk. The best way to think about this is if you where actually lending the money out of your personal savings. How are you going to be paid back? Using this mind set can help you identify how a commercial underwriter looks at projects.
The commercial real estate market is still a little rocky, but there are lenders that are still willing to lend on viable projects with good sponsors. It’s important to fully consider all aspects of a project before investing. Using these guidelines is a good first step in ensuring you are looking at the right projects and not wasting your time or your client’s time.