What to Know About Land Financing

IRVINE, CA—When it comes to land loans, lenders have a sensitivity to product type, prefer infill vs. greenfield product and shy away from sites that are not fully entitled, Mark Strauss, managing director of Cohen Financial's Irvine office, tells GlobeSt.com. Strauss and Cohen's Robert Quarton recently secured an $18-million refinancing of a land parcel in the Uptown Newport master-planned development located near the intersection of Jamboree Rd. and Fairchild Dr. in Newport Beach, CA. The property is a premier development site in Orange County, with entitlements in place for 225 townhomes or condominiums. We spoke exclusively with Strauss about the loan, why lenders are reluctant to finance land purchases and other aspects of land financing.

GlobeSt.com: What stands out for you about this loan?

Strauss: The first thing is that the site is very unique and valuable. There is a limited number of residential units allocated to the John Wayne Airport area. We had to explain that to the lending community because on a per-acre basis the land would seem to be expensive, but when you begin to analyze it on a per-unit of entitlement, you can see where the value is created.

GlobeSt.com: Why are lenders so reluctant to finance land purchases at this point in the economy?

Strauss: The problem with land is that it typically appreciates significantly in value later in a cycle and is the earliest in a downturn to depreciate in value. Unlike a building that is throwing off income, which you can use to offset expenses and debt service, which then gives you the ability to hold through a cycle, land absorbs income—there's no cash flow from it. There are taxes to pay and overhead associated with it, so for most investors, it is probably the most speculative type of real estate asset.

GlobeSt.com: What can borrowers do to help facilitate the land-loan process?

Strauss: There are a couple of different types of lenders that will lend on land, but all of them want to see what a clear path to development. Typically, they are more likely to make the loan if that path to development involves some type of construction as opposed to a land-sale takeout strategy. Before the lender puts a loan on land, they want to know fairly definitively what the plan is and that it's not dependent on some third party to execute on the vision. They want to see the borrower execute the plan.

GlobeSt.com: What else should our readers know about land financing?

Strauss: Typically, land loans are 50% of value with some stretching to 60%, but that's typically where the comfort zone of the lender ends. If you're looking at banks, interest rates are lower than other types of lenders—banks will be somewhere in the 4%-to-6% range, with one or two points of cost—and many of those banks will only consider land loans if they are going to be the construction lender also. Then there are the private equity, opportunity funds or hard money, where interest rates will run between 8% and 14%, with two to four points associated with the loan.

Lenders also have a sensitivity to product type and prefer to lend on the four basic food groups of commercial real estate—apartment, retail, office and industrial—more than an esoteric type like hotel, self-storage or some other kind of less-common exit-development strategy. They are also much more inclined to lend on urban-infill product as opposed to a greenfield path-of-growth land and are also more likely to lend on fully entitled sites vs. sites that have to go through some entitlement process. There are so many vagaries in entitlement that make it difficult for lenders to get their arms around those deals. Banks are typically looking at recourse guarantees, whereas with some of the private-equity deals you can find non-recourse loans, which will be reflected in the increased interest rates.