Why is development debt int so much > senior?
A deal I'm doing atm we have a c. 800m loan facility which is a blend between the acquisition loan and development debt, both coming from a single lender for a single asset.
Both the senior and Dev have a floating EURIBOR base and a c. fixed spread of 3% and 7%
In this case where the development debt isn't an outside party thus if the deal goes belly up the senior lender is 1st in lien for the senior then 2nd on claims to the dev debt and then we would be 3rd so why do they have such a high price of risk?
I totally understand why it would be priced at 7% if it had been an alternative lender as they are second in lien.
My thoughts are that it's acting like a piece of mezz and they need to be rewarded for their risk as they are putting a lot of eggs into one basket? But it would take a significant wipe out in value to even come close to being on par with the outstanding loan balance.
Thanks!!!
800m loan?
Baller
Yeah It's pretty absurd hahaha.
A couple of reasons for the high pricing. If you default in the middle of construction, the lender has to finish the construction themselves. If when you finish construction, the building doesn't lease like you projected an then default, it becomes their problem. It is basically Mezz debt They want a piece of your upside for allowing you the ability to do the development with their money.
Thanks man!
Ok I'll bite (with the limited info posted). A big component of pricing is LTC attachment/detachment points. Say the total cap of deal is $1.2bn of which $600mm is funded at closing (50% LTC), with an additional $200mm in the future for capex/development on the asset, bringing the LTC to 66.7% LTC. The 50% attachment to 66.7% detachment LTC will be priced more expensive for the incremental risk associated with those dollars in. Further, development carries displacement to existing operating assets and potential cost overruns, especially when a GMP is not in-place and drawings are early in the process.
Prior posts included other core components so I won't repeat.
The collateral doesn't exist up front. The borrower is building it.
Fair but even with a 20% fall in the value of the existing unit before the development, it would still cover both the dev and existing unit debt.
Lenders don't always look at value. Most look at deals on an on-going cash flow basis. So some of the risks in the deal is that you guys are taking on the interest rate risk, where 3-5 years down the road your development projects may complete, but won't reach rents/occupancy to service debt service.
Plus, the lender is probably going to sell some of the paper and other lenders buying will require a much higher interest rate for a deal like that. That's my thought
All the posters are spot on regarding to why pricing is different. However, 400 bps difference is a lot in my opinion unless acquisition loan is 50% loan-to-purchase and development is 85% loan-to-cost. It could also because of the big loan amount with one lender.
this was horribly explained by the OP and i literally cannot figure out what he's talking about, but in general, construction loans are ACTUALLY CHEAPER than 10-year permanent debt because they are shorter-term and variable rate.
Cheaper how? In essentially every way possible, construction loans are more expensive vs. permanent loans. In spread, fees, recourse, guarantees, documentation, negotiation (hairier vs. perm. in my opinion), etc.
Only thought where your statement makes sense is that permanent financing amortizes (possibly could get a few years IO on the front end) vs. typical IO for construction lenders, and the overall "chunk payments" one would make. That's comparing apples to oranges though, given the fact that construction loans are meant to be short term.
Agree with you on the hairiness et. al, but the thing about construction loans is that the pricing barely moves the needle since the money's out for such a short period of time. A couple hundred more or less bps has a shockingly small impact on the total economics of a deal
Is there still a shortage of large construction lenders out there? My understanding was that last year only Ozarks was a player.
The market has surely thinned out. Non-recourse condo lenders (removing "predatory lenders")... VERY few players. with BOTO being one of them.
It's as thin as ever. If you want a large non-recourse senior for construction and Ozarks doesn't want to do your deal, then god speed. There are VERY few other options (in the bank category) and they will all offer less attractive deals. In fact, a prerequisite for them even looking at your deal will be "Did Ozarks quote this?", because if they did, then they won't even waste their time.
Things Ozarks won't touch: anything with a ground lease. Don't even bother. Better yet, stop with the fucking ground leases.
Things Ozarks won't do: go above 50% LTC, unless you have a great broker and your deal is really good. And even then you'll only squeeze out a few more points of leverage at best. They won't capitalize mezz interest reserves into their stack/ leverage.
Things Ozarks will do: give on important ancillary deal items like giving you the obnoxiously high dev fees you want, cave on reporting requirements, give extended term and easy extensions etc.
There are always the debt funds that will do your deal at over twice the cost, but....WAIT....95% of them will need to lay off an A to get their yield, but who is going to pick it up if it's not Ozarks or someone else?
So yes, the construction loan market is as pathetic as ever and Ozarks is basically the fat cat calling all the shots.
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