Key points on development lending

Based on the most helpful WSO content, here are the key points lenders typically consider when assessing the risk-return ratio for development lending:

1. Pre-Development/Flat Lot/Shovel Ready with No Income in Place:

   • Guarantor Strength: Having an excellent guarantor is critical. Lenders want to see a strong financial backer who can cover potential shortfalls.
   • Land Lending Terms: Lenders assess what costs can be capitalized into the acquisition loan and the terms of the land loan. They also evaluate the feasibility of the project based on the developer's experience and market knowledge.
   • Dead Deal Costs: Pre-development costs can be a significant risk. If hard costs or other factors increase unexpectedly, the deal might not get financed, leading to sunk costs.
   • Local Market Dynamics: Understanding the local market and the "mental map" of renters or buyers is crucial. This helps determine if the project is viable in the given location.

2. Refinancing (Refi):

   • Stabilized Value: The property must have a stabilized value significantly higher than the development cost. For example, a 30%+ increase in value is often necessary to make a refi viable.
   • NOI and Cap Rate: The stabilized NOI and the cap rate at stabilization are key factors. These determine the asset's value and whether it can support a higher LTV loan.
   • Debt Payoff and Equity Recapture: Lenders look at whether the refi proceeds can cover the outstanding construction debt and allow the developer to recapture equity or buy out LPs.
   • Reserve Accounts: Releasing operational and construction interest reserves during a refi can provide additional cash flow.

3. Replacement Cost:

   • Replacement cost plays a significant role in risk assessment. If the cost to build is close to or exceeds the market value of the completed project, it increases the risk. Developers need to ensure that the project creates value above the replacement cost to attract financing and justify the investment.

These factors collectively help lenders evaluate the risk-return profile of a development project and determine its feasibility.

Sources: Alternative Lenders & the End of Risk Taking for Banks - Opportunity or Risk?, Great Deals You've Recently Done, Real Estate Development Modeling, From Real Estate Finance to Founder of Development Company - Q&A, Learning curve in development