I learned something interesting about commercial real estate finance this week. To understand this important lesson, I need to first provide you with a little background and context.
Most (from the) ground-up commercial construction loans are made by commercial banks. The reason why is because commercial construction loans require progress inspections and the payment of subcontractors using some sort of voucher system as construction progresses.
After a subcontractor completes some construction work, he typically submits a payment request, known as a voucher. The developer and/or the general contractor signs off on the voucher, and then the voucher is submitted to the construction lender for payment. When the construction lender is a local bank, its fairly easy for the loan officer working for the bank to quickly drop by the property to verify that some work was actually done.
So when you think of a construction lender, think of a commercial bank located close to the property being built. Okay, but what happens if almost every commercial bank in the country is too scared to lend? Hmmm. Now it gets a little tougher to build anything.
There is a class of commercial real estate lender that we'll call a mortgage fund. Some of these mortgage funds are huge, while others are tiny. You could have a $500 million mortgage fund or just a $2 million mortgage fund. Obviously the big funds make the big loans, and the small funds make the small loans.
But these mortgage funds of varying size have a number of characteristics in common. First of all, mortgage funds charge an interest rate that is typically 3% to 8% higher than the bank. Secondly, mortgage funds like to make short-term bridge loans (1 to 3 years).
Lastly, mortgage funds (bridge lenders) seldom make construction loans. The reason why is because most mortgage funds are single-office, national lenders. Therefore, mortgage funds are seldom located close to the property being built. Most also lack experience in making construction loans, and they are just not set up to administer construction loans.
Okay, so you can imagine my surprise this week when I read in a national commercial real estate magazine about a big mortgage fund that had just funded a $35 million construction loan on a huge, new residential condo project.
This bridge lender was able to make this new construction loan because it blanketed two other standing commercial properties. The mortgage fund blanketed a large shopping center and a large office tower owned by the same builder.
So how can you finance new commercial construction in a market where every commercial bank is afraid of its shadow? The answer is to blanket other property!
