Credit enhancement of commercial construction lending has a new, important twist to the traditional (full) payment and performance guaranty: the burn-off events go beyond valuation and debt service thresholds to also include many of the check list items utilized by permanent lenders. The burn off has a new price.
Finally, construction loans are bubbling up for the “right” real estate developer in the “right” market, with the “right” product, with the “right” tenants in tow, and with the “right” amount of cash to bake into the project (before the first substantial draw on the construction loan). And the competition among the lenders often gives the developer (or the key sponsor) the ability to back away from the full payment and performance guaranty – a staple of construction lenders who require it until the project is built, occupied and cash flowing (link to Federal banking materials). In the “old” economy (pre-2007), the burn-off triggers or bench marks were simple: show a specified appraised value and a healthy debt service coverage. In the “new” economy, what may project by a construction lender (at the closing of the construction loan) to be an attractive project for a take-out lender might miss the mark, as those lenders move on to a more favored asset class (not commercial real estate), or to a more favored type of commercial real estate – or to a different region of the country. (GASP) So, what is a construction lender to do? Add items typically found on the take-out lender’s check list as “new” burn-off triggers or bench marks. Why? Make it easier to quickly close the take-out loan, so that the construction lender can book the profit. Sure, the construction lender makes a good return on the loan during construction. But it does NOT want the project as the ultimate return. It wants the money back. Here are a few check list items showing up as burn-off conditions:
- project and tenant certificates of occupancy
- tenant estoppels and subordination agreements (running for the benefit of any future project-secured lender)
- as-built survey
- down-dated title policy, with endorsements typically required by permanent lenders (including any assignee of the loan as an insured)
- copies of all operating permits
- copies of evidence of utility service
- as-built plans (with approvals by applicable third-parties, such as an architectural control committee)
- . . .
Of course, this can cause some heart-burn or angst on the part of the developer. One reply is this: how is this really different from the “one-time” close programs (in the old economy), where a bank and a life insurance company teamed up to do exactly this same thing (close the construction loan and then agree that if the specified check list requirements are met, then the life company would take over the loan, but modified with a new interest rate and a new maturity date)? The only difference is the economy: life companies don’t need to team up with a construction lender to source new loans. With the CMBS market “challenged” and few banks or mortgage REITs active in the long-term finance market, life companies are . . . enjoying it. If you have any thoughts or comments, please post them below.