Getting to Yes: What It Takes to Land Construction Debt Today
Commercial real estate, for all its intrigue and outsized egos, can be at times a rather staid business—just count the long hours spent fiddling with spreadsheets and attending breakfast panels at convention hotels.
Still, sometimes the work provides its own brand of adrenal pleasures. When it comes to originating construction loans, even the coolest practitioners will tell you there’s nothing routine about handing a $50 million check to a developer with little more to show for his project than a business plan and an artist’s sketch.
“If you’re going to get into construction [lending], you’ve got to have a pretty strong stomach,” said Thomas Whitesell, the head of construction lending at CapitalSource, a big balance-sheet lender based in Maryland. “You have to structure loans for the issues you’re going to have—because every construction deal has issues.” The only thing that’s predictable, in other words, is unpredictability.
Right off the bat, that sense of hazard winnows the field of debt investors who are willing to take part. Commercial mortgage-backed securities (CMBS) lenders, for instance, are mostly off the table as a source of funding. Even though banks that originate securitized mortgages have lately grown ravenously competitive for financing opportunities, construction loans don’t match up well with the demands of securities investors.
“CMBS, and mortgage-backed securities in general, work well with long-term, fixed-rate loans with a somewhat uniform structure and relatively predictable cash-flow streams,” Joe McBride, a research director at Trepp, said in an email. “CMBS investors want longer duration bonds, [typically with an] eight- to 10-year weighted average life, so you need long-term loans as collateral. Also, construction loans often have future funding components where the loan balance actually increases over time based on different phases of development.” Bond investors would find it challenging to incorporate increasing loan balances into their debt strategies, McBride said.
That leaves more work in the construction loan space for banks and, increasingly, debt funds. To get a sense of their rapidly rising profile, search no further than one of New York City’s biggest financing deals of the year, advised Tom Traynor, an executive vice president at CBRE’s debt brokerage.
“Look at what Blackstone did for The Spiral with Tishman Speyer,” Traynor said, referring to Blackstone’s massive $1.8 billion loan on the 65-story skyscraper under construction at Manhattan’s Hudson Yards that closed in April. “In the past, that would have been a more traditional global bank loan—and Tishman Speyer has as many relationships [with big banks] as anybody else.” But they clearly found what they were looking for with the giant debt fund.
Because banks can be so hesitant to wade into a deal with any elements that threaten a routine and seamless buildout, even prolific developers with long track records can find it difficult to woo traditional lenders for projects that lie in any way off the beaten path. Michael Maturo, a managing director at RXR, recalled that the mega-developer first sought a bank to fund its massive Garvies Point project, a 1,100-unit development in Glen Cove, N.Y., on Long Island. But because the location is a Superfund site that once housed a munitions factory and will require significant remediation, traditional lenders weren’t interested.
“The banks had a hard time getting their arms around the project,” Maturo said. “So we went to the street to find [nontraditional financing from a source] that was able to underwrite the complexity a little bit better.”
In the end, construction money was lent by an alternative financing vehicle that sold the senior portion of the debt to a bank, Maturo said. (The executive declined to identify the lenders more specifically.)
Even as eager as funds are to dive headfirst into high-margin construction lending, however, they too have to keep in mind that markets often swing faster than I-beams can rise.
“In New York or in most gateway markets, when you’re making the decision to build something, the biggest question on sponsors’ and lenders’ minds is, where are we in the cycle?” said Jonathan Chassin, a managing director at Moinian Capital Partners, the financing arm of The Moinian Group. With 10 years of expansion in the books for the American economy, lenders like Moinian are forced to consider that a recession could hit before new construction projects have a chance to get out of the ground.
In that way, construction lending forces a conservative mindset on practitioners in all walks of the sector. Potential sponsors face stubborn gatekeepers long before their blueprints wind up on a lending committee’s conference table. In some cases, even though finance brokers work for borrowers, brokers might delay showing a perspective project to lenders if they doubt the proposition has the right stuff to win a debt deal.
“We have to first act as bankers ourselves [to study] the metrics of the deal and get to a certain comfort level,” said Dmitry Levkov, a managing director in Colliers International’s finance division. “We do a lot of work early in the process educating borrowers.”
If their study of a project raises questions about a borrower’s ability to see a project through to the topping out, Levkov’s team might simply tell clients thanks but no thanks. Putting a half-baked plan in front of the wrong lender could hurt not only the developer’s reputation but also that of the brokerage.
“A lot of folks run around trying to get financing, and we have to do our own due diligence,” said Jeff Donnelly, a finance broker at Colliers. When sharing potential deals with a lender, “you can’t bring in a parade of schmendricks.”
David Eyzenberg, an investment banker who arranges some commercial construction debt through his firm Eyzenberg & Company, said that the most mature finance brokers have the wherewithal to pick their spots carefully.
“When you’re just starting out [as a finance broker], you run around trying to slay the dragon. You pretty much take any” business you can get, Eyzenberg said. “Those that are more established are generally working only on deals that are executable. We find ourselves saying no [to] substantially more deals that come to us than we say yes to. I only get paid on success.”
Eyzenberg’s peers in the industry follow the same logic, he said. “The bigger shops clearly aren’t taking on a butterfly farm in Panama.”
If a project’s design, budget and lease-up appear unimpeachable, a borrower’s reputation and track record can sometimes be the deal breaker, especially if it’s a project under development by a small shop or under the aegis of an individual mastermind.
Gary Barnett, the founder and president of Extell Development Company, said that his firm’s high profile and strong track record go a long way toward opening access to construction financing. In the mid-2010s, the construction lending market briefly ran into the doldrums, but Extell was able to leverage its reputation to secure a syndicated bank loan for construction on a marquee Manhattan residential project, One Manhattan Square in the island’s Two Bridges neighborhood.
“It took us some time to get it done, but in the end, we got [financing],” Barnett said. “I think the market is open to well-thought-out plans.”
If constructions lenders sometimes seem stingy, Barnett argued, it might be developers who are in fact the guilty parties.
“It’s hard to get loans when the projects are not so good,” Barnett said. “You have a lot of projects today that have paid a lot of money for land…and now interest rates have gone up. The bankers don’t like projects that don’t pencil out.”
From Traynor’s previous experience as a real estate banker at Deutsche Bank, he said he knows firsthand how sharply lenders differentiate large institutional developers and smaller operations that aspire to manage construction projects.
“If it’s a sponsor no one’s ever heard of, that’s going to be a problem for us,” Traynor said. His practice at CBRE is focused on large-dollar financings that typically generate competition among lenders for the business—such as the process of securing a multi-hundred-million-dollar conversion loan for the Terminal Stores project in Chelsea, a former warehouse that L&L Holdings and Normandy Real Estate are converting into office space. But the market for lending to little-known developers is so different, in fact, that some finance brokers might specialize in those clients alone.
“We have competitors out there doing $50 million construction loans with guys you and I have never heard of,” Traynor said. “They may take that assignment on because they could be compensated very well,” given that finding a willing lender on a more obscure deal could involve an in-depth search. “It may make sense from a time-management perspective.”
Relatively unknown sponsors seeking bank loans may get more scrutiny than they would if they approached a debt fund.
“Banks have become more conservative,” said Richard Horowitz, a principal at finance brokerage Cooper Horowitz. “If it’s a sound sponsor, with a lot of equity…you’re going to get a loan from a traditional lender.”
Developers who lack a strong track record in a particular asset type, on the other hand, face an uphill battle. Some first-time builders who have experience buying and selling real estate enter the construction financing market thinking their property management expertise will make debt easy to obtain based on their experience. “But banks making construction loans don’t think the same way,” Levkov said.
If a sponsor proposes to build a new hotel, “the bank’s first question will be, ‘Have you ever built any hotels?’ If the answer is no, they’ll have to find a co-developer with experience building hotels,” Levkov said, adding that construction lenders’ pickiness means it takes many construction projects three to six months to match with a financier.
Lenders are just as cynical if a developer doesn’t have experience in a certain market or even with a specific mode of construction, according to Eyzenberg.
“If you’re a New York developer and you’re going to Atlanta to build for the first time, sometimes it’s problematic because you don’t know the local [fundamentals],” Eyzenberg said.
“The same is true if you’ve only built stick-frame and you want to build a 30-story concrete building. That’s really different.”
“People give you money because they think you can replicate your past success,” the investment banker added.
“If you just own or operate property, lenders don’t accept that experience [as being sufficiently relevant],” Donnelly, a Colliers executive director, said. “Very successful contractors are also under scrutiny as developers because it’s thought to be a different responsibility.”
Whitesell, the CapitalSource construction-lending manager, confirmed that many of the banks that are active in the sector draw up a rigid set of guidelines that approved loans must adhere to.
“A lot of banks have a philosophy [that a construction loan] has to fit into a box,” Whitesell said, an approach he thinks occasionally handcuffs his less creative competitors. “If you have a mentality like that, it’s not going to be as successful. You have to want to do construction with a lot of moving parts.”
If a borrower’s scheme does not conform precisely to banks’ specifications, projects can stall in front of institutional lending committees. Late last year, local developer Land South hired Eyzenberg & Company to arrange a $23 million construction loan for an entertainment venue and retail center in Myrtle Beach, S.C. But though the beach town is a popular vacation spot that attracted about 10 million tourists per year, banks hesitated to fund the project.
“We could not really get a local bank interested,” Eyzenberg recalled. “It was something new for that market, and the sponsor had not built anything like that before.”
In the end, Eyzenberg was able to secure a 60 percent loan-to-value financing from New York-based Gamma Real Estate, stating in an announcement about the deal that he received a term sheet from Gamma “within two hours.”
Debt funds, indeed, might take a more generous perspective of less experienced borrowers—provided they’re willing to pay the higher returns that fund investors want. Chassin, for instance, takes a glass-half-full view of lending to newer borrowers from his company’s fund-based platform.
“Relatively speaking, development is a better return than you’re getting just buying a building these days,” Chassin said. “If you’re a smaller developer and you’re looking to go up to a development bigger than anything you’ve done, we’re willing to take the risk.”
And because they’re not constrained by so-called high-volatility commercial real estate lending rules—federal statutes that require banks to maintain hefty reserves relative to the volume of construction loans they write—debt funds are frequently willing to deliver more debt at a higher leverage ratio for a given project.
“Funds are at times a little bit stronger on the dollars than banks,” said Abraham Bergman, a co-founder of New York mortgage brokerage Eastern Union.
Execution time matters as well. “Funds also promise a quicker yes or no. That’s a good thing,” Levkov said, “because it puts pressure on banks to speed up their decisions, too.”
On the other hand, banks can leverage the broader range of nonlending services they offer to come up with an attractive package for developers. Institutional lenders sometimes use the promise of a construction loan to goad a builder or property-management company into moving its deposit accounts to the lender’s books, agreeing to stretch to make an otherwise elusive construction loan if the borrower agrees to use the bank’s checking account to store cash.
“It’s easy to get a construction loan from a bank, but only if [the bank] sees an opportunity,” Donnelly said. It’s not unusual for banks to ask the Colliers broker to put his construction-lending clients in a room with their depository bankers. “If clients are smart, they’ll go along with it,” Donnelly said. Relationships like that also can lead to easier refinancings later on, he added.
Finally, developers’ ability to procure affordable materials and labor—and to manage the endless complications and contingencies of a full-scale construction project—raises yet more crucial questions for lenders of all stripes to grapple with before they reach for the “approve” stamp. When CapitalSource is making a construction loan, Whitesell likes to sit in a room with the potential developer and the lead contractor to watch how they interact.
“You can easily see in a conversation who has the upper hand,” Whitesell said. “‘What’s going to happen in this situation? What’s going to happen here?’ We know what questions to ask—[you learn from] making mistakes through the years.”
But though the list of snags like inexperienced builders, rising construction costs, ascending interest rates and skeptical banks filter which projects break ground, stakeholders on all ends of the deals agree that lenders have maintained their appetite for good opportunities.
On the whole, “Extell has not had any problem” finding construction funding, Barnett said.
“It’s been busy, though I wish it were a little busier,” Horowitz said. “If you have the right deal, it’s still going to get financed. There’s more capital than deals.”
With additional reporting by Max Gross.