In this Insights Series Post we thought we would share the results of a recent marketing campaign we ran to place debt financing on a parcel of land. This sheds light on how challenging the current market is for one of the most difficult asset classes to finance.
Broadly speaking, land is one of the most volatile asset classes within our industry. Its value can fluctuate up and down at a higher rate than cash flowing properties, and its value is quicker to adjust. For example, when real estate prices are rising in the market developers scramble to find suitable sites to build their projects. This drives land prices up, and they can move very quickly since construction costs and rents are relatively stable in the short term.
Conversely, when the market is down land prices can fall to the floor. Development projects don’t pencil so there are no buyers for land, and therefore no demand. There is also no cash flow coming from a parcel of land so no available funds to service debt or real estate taxes, and no cash flow to prop up value. All of these reasons make land financing very challenging in general, and typical terms include lower leverage and higher pricing than cash flowing commercial property. In today’s market it’s even tougher and more expensive with many lenders still sidelined with portfolio issues due to the recent rise in interest rates.
The land parcel we recently took to market had many positive attributes to it. It was located within a major gateway market, it was fully entitled for a multifamily development, the sponsor was well-heeled and experienced, and the request was for modest 50% LTV leverage. Despite all this, we marketed the opportunity to a wide group of 40 different lenders who have historically financed land as part of their lending program. This was a relatively large marketing campaign. Here are the results and what the lenders said:
Passes: of the 40 total lenders we received 35 “Passes” (which is a polite way of saying no). Here is a summary of the various reasons for the decline:
- Generally Not Lending on Land Right Now: 24 lenders out of the 35 passes. Most indicated that they were seeing good loan opportunities on existing cash flowing properties so there wasn’t a desire to put a land loan in the portfolio.
- Too Small of a Loan: 4 lenders (the requested loan was for $10MM btw).
- Still Not Back in the Market Lending: 2 lenders
- Leverage Request is Too High: 1 lender
- Project/Sponsor Specific Reason for Decline: 2 lenders
Undecided: 2 lenders within the campaign never told us “yes” or “no” as to whether they were interested in pursuing the loan. It’s quite common to have a few of these in any wide marketing campaign. We have learned over the years that you can only wait so long for a lender to make up their mind and at some point, you need to cut it off and close the campaign.
Quotes: We ended up taking 3 quotes for the financing which provided a few options for our client, but as you will see the options were quite expensive and very tough deals to take.
- 50% LTC at WSJ Prime + 5.50% floored at 14%. 1 year deal with a 2% lender origination fee and a 1% exit fee. Full recourse. (The APR on this quote is 17%, and since the quote is based on LTC not LTV the borrower would actually have to put cash in to make the loan work!)
- 50% LTV at 15% fixed for 1 year with a 5% origination fee, full recourse. (This is a cash neutral offer but the APR is an astounding 20%! I’ve never seen anything like this before)
- 50% LTV at SOFR + 6.45% floored at 11.75%. 1 year deal with a 2.5% origination fee and a 1% exit fee. Full recourse. (This was the best deal with an APR of 15.25%!)
As you can see the loan quotes we received were very high in price and very tough for the borrower to move forward with. The market had very little appetite for land financing, even for entitled multifamily land in a major gateway market with low leverage. The cheaper lenders all steered away from the asset class in general and only the higher priced market participants made opportunistic offers.