Commercial Loans Blog

Land Cost in Commercial Construction Loan Underwriting

Posted by George Blackburne on Thu, Jun 27, 2013

Despite the recent turmoil in the stock market - Bernanke just announced the tapering of Quantitative Easing III - the U.S. housing and construction industry is recovering.  There has been almost no new residential construction for six years, yet the U.S. population has increased by 236,000 per month since the begiining of the Great Recession in mid-2007.

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In the meantime, tens of thousands of home were foreclosed, abandoned, and left to vandals, water damage, broken pipes, and mold.  The bottom line is that the U.S. needs more housing construction.

Normally I discourage commercial mortgage brokers from wasting their time on commercial construction loans; but if a deal fell in your lap today, and you had plenty of small permanent commercial loans in the pipeline, I would not think you were a complete idiot for investing a little time in an apartment construction loan request. 

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The reason why I am writing to you today is because I saw a $15 million multifamily construction loan request enter C-Loans.com today.  It looks like a do-able loan, but the broker screwed up big-time when he entered the deal.  Unless he fixes his loan application, it will never get approved.

You will recall that the Total Cost of a commercial construction project is the sum of the Land Cost, the Hard Costs, the Soft Costs, and the Contingency Reserve.  In the old days, commercial banks would regularly make commercial construction loans of 80% (and sometimes 90%) loan-to-cost (Loan-to-Cost Ratio).  In other words, if the Total Cost of the project was $10 million, the developer only had to contribute $2 million (and sometimes just $1 million). 

Today commercial banks are still reeling from their losses in commercial construction loans during the Great Recession.  Therefore few commercial banks will make commercial construction loans higher than 75% loan-to-cost.

So how did this commercial mortgage broker screw up his C-Loans app?  The developer apparently bought this land in Brooklyn in 2005 for $1.5 million.  Since 2005 Brooklyn has undergone a huge positive transformation.  Everywhere you look in Brooklyn the property is being gentrified.  This land that he paid $1.5 million for in 2005 is now worth $5,750,000!

Unfortunately when this broker completed his C-Loans app, he inserted $1.5 million as the cost of the land.  No-no-no! Even though the developer had TONS of equity in the land, the lender won't see it.  All he'll focus on is loan-to-cost ratio of 79.1%.  That ratio is too high, and the deal will be turned down.

What should the commercial mortgage broker have done?  He should have entered the current market value as the cost of the land.  After all, if the developer was buying the land today, that is what he would have to pay.  If we use the correct land value - $5.75 million instead of $1.5 million - the loan-to-cost ratio of this deal is less than 63%.  In other words, the deal will be approved!

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Topics: land costs