Developers Need to Find Alternative Debt Sources

Construction financing can be challenging in today's market, and developers need to be open to alternative sources of debt and focused on their needs and product type to secure funding, according to David A. Parker, senior managing director at Charles Dunn Co. With construction financing—at least in some asset classes—tightening, we sat down with Park for an exclusive interview. Here, we discuss the challenges for developers, which asset classes are getting the most attention and the financing trends defining the market.

GlobeSt.com: What are the biggest challenges developers are facing on securing construction loans?     

David A. Parker: First of all, developers today have to be laser focused on their product type and area of expertise in order to prove themselves as strong candidates for securing a construction loan.  Additionally, major banks have reduced their construction lending activity due to several factors including HVCRE and general concerns of overbuilding. Finally, because lenders are tightening the reigns, they are being very selective about approving only the least leveraged loans and the most well-heeled developers with deep balance sheets.

GlobeSt.com: How are you advising clients in this current lending environment?  

Parker: Developers need to explore alternative sources of debt, equity and capital from sources such as debt funds that can fill all levels of the capital stack and achieve higher loan-to-cost ratios. Non-traditional sources are also more receptive to speculative projects or special purpose developments and will allow non-recourse debt.  For these reasons as well as having no profit participation, developers are willing to pay their increased costs of 100-500 bps in many instances.  However, even these alternative capital sources will ask for substantial equity in a project even if a developer has strong equity in appreciated land.

GlobeSt.com: What trends are you seeing from a lender standpoint?

Parker: Lenders are chasing yield.  The proliferation of debt funds and full capital stack lenders has more than filled the gap left by the major banks. Private developers actually prefer non-recourse high leverage first mortgage deals in contrast to trying to put together a traditional recourse bank construction loan, traditional mezzanine or preferred equity.  The cost difference isn't material to profitable, well-selected developments.

GlobeSt.com: What will each property sector see development-wise over the next 18 months?

Parker: Drive-thru quick service restaurants are a must for most small food retailers now and development will be positive for this asset type over the next year-and-a-half or so.  As consumers continue to increase their online purchase activity, multi-tenant retail development will prove to be difficult unless it is pre-leased to credit tenants.  The big box days are fading fast for most retailers.  To a similar degree, office development will require strong pre-leasing or must be located in low vacancy infill markets with huge barriers to entry.

Also due to the Amazon effect, as well as the lack of available land in most urban areas, industrial/distribution will continue to be a strong sector but little to no new development will happen. With utility districts and cities raising fees dramatically, entitlement timing continues to drag out and adds another barrier to entry.

Multifamily will still be strong in well-located projects, but mixed-use urban development has become more difficult to execute due to competition, increased governmental red tape, excessive fees and neighborhood opposition groups. The dreams of urban infill, transit-oriented apartments are becoming increasingly difficult to justify. Workforce housing is in high demand, but due to scarce land, entitlement and construction costs, this product continues to lag in many markets as developers tend to focus on higher-margin luxury product.

Overall, developers should continue to prepare for lower project leverage, be open to new capital sources and, of course, select the most well-located and economically feasible projects.