Choosing the right construction lender for a multifamily project is a decision that most developers make under time pressure, when the land is under contract, the equity is committed, and the closing is approaching. Making it under those conditions produces a loan with terms that are adequate rather than optimal, from a lender whose construction loan administration process the developer has not had time to evaluate. The developers who consistently get the best construction loan terms are the ones who have invested in lender relationships before they need the loan, not while they are trying to close it.
The following is a practical guide to understanding the construction lending landscape for multifamily development and to structuring lender conversations in a way that produces the best available terms when the project is ready to proceed.
The Construction Lending Landscape
Multifamily construction lending is divided into several distinct categories of lender, each with different priorities, different pricing, different loan structures, and different preferences for project type and market.
Community and regional banks are the most common construction lender for mid-size multifamily projects, those in the $5 million to $50 million range. They typically offer the best pricing (lowest interest rates and fees) for the projects they are most comfortable with, they maintain ongoing relationships with borrowers through multiple projects, and they have local market knowledge that national lenders sometimes lack. Their limitations: concentration limits mean they can only lend so much in a single market or to a single borrower, their internal approval processes can be slower than institutional lenders, and their maximum loan sizes are lower than large regional or national banks.
Large regional and national banks serve larger projects, $30 million to $300 million and above, and can accommodate the loan sizes and complexity that exceed community bank capacity. Their pricing is generally competitive with community banks for the strongest sponsors and projects, and their construction loan administration is typically more standardized. The tradeoff is a less personal lending relationship and, for some borrowers, a more demanding underwriting process that requires more documentation and more extensive sponsor review.
Debt funds and bridge lenders offer construction financing for projects or borrowers that do not meet conventional bank underwriting standards, higher leverage, shorter track records, transitional markets, or project types that banks are less comfortable with. Their pricing is substantially higher than bank financing, interest rates that may be 300 to 500 basis points above bank rates, but they offer flexibility in underwriting and speed in closing that conventional banks cannot match. They are the right tool for specific situations, not a default alternative to bank financing.
Life insurance companies and CMBS are typically not construction lenders, they provide permanent financing after a project is stabilized, not the construction-period financing that builds the project.
What Construction Lenders Evaluate
Construction lenders evaluate four things: the sponsor, the project, the market, and the exit. Understanding their evaluation criteria allows developers to present their projects in the way that best addresses lender concerns.
The sponsor. Lenders are making a multi-year commitment to a borrower and, to some degree, a bet on that borrower’s ability to execute. They evaluate the sponsor’s construction experience, specifically whether the sponsor has built the same project type before and whether prior projects were delivered on schedule and within budget. They evaluate the sponsor’s financial strength, net worth, liquidity, and the ability to contribute additional equity if the project encounters problems. And they evaluate the sponsor’s reputation in the market, their relationships with subcontractors, GCs, and the lender community.
The project. Lenders evaluate the construction budget for adequacy, which is why the bank’s construction loan monitoring program exists, and the project’s design and entitlement status. A project with full construction documents and an issued building permit presents a more bankable package than one with schematic design and a pending entitlement. Lenders also evaluate the project’s compliance with their internal guidelines: loan-to-cost ratio, loan-to-value on completion, debt service coverage on permanent basis.
The market. Lenders evaluate the market’s support for the project’s projected rents and absorption, whether the market study underlying the pro forma is credible and whether the projected rents are achievable given current and anticipated competitive supply.
The exit. Construction loans are short-term, typically 18 to 24 months plus a few extension options. The lender’s exit is the permanent loan, either a conventional permanent loan, an agency loan (Fannie Mae or Freddie Mac), or a sale of the project. Lenders evaluate whether the permanent loan exit is realistic given current permanent financing market conditions, and whether the project’s projected stabilized value supports a permanent loan that is large enough to repay the construction loan.
How to Have the Lender Conversation
The most productive lender conversations happen before the project is fully structured, when the developer can present a concept and get early feedback on how the lender would look at it, rather than presenting a fully developed loan request and negotiating from a position of time pressure.
Bring to the initial lender conversation: a one-page project summary (location, program, project type, sponsor, approximate costs, and projected timeline), a preliminary site plan or project concept, and a high-level financial summary (total development cost, equity, projected loan amount, projected rents and NOI, and projected completion and stabilization dates). Ask the lender whether the project is within their lending parameters, what questions they would need answered to consider it, and what current construction loan pricing looks like for projects of this type and size.
That conversation, conducted six to twelve months before you need to close the loan, produces two things: early feedback on how bankable the project is and an opportunity to develop the lending relationship before the project is under time pressure. Lenders who have been following a project’s development from concept through entitlement are materially more comfortable with it at closing than those who see it for the first time when the loan request arrives.
Innergy Integral advises developers on construction lender selection and loan structuring as part of the development advisory services we provide from site evaluation through construction completion.
Related: Multifamily Development Services · Construction Loan Monitoring · Multifamily Construction Loan Structure · Development Advisory Guide
Markets: Multifamily Development Seattle WA · Multifamily Development Dallas TX · Multifamily Development El Paso TX