Insurance and Economy and Banking & Finance and Real Estate & Retail

For funding, developers may need to think outside box: Amid tight credit markets, getting a project built often takes alternative financing sources, creative approaches

October 27, 2008

Although the spigot of bank financing has slowed to a trickle, money to fund commercial development projects remains available from alternative sources.

Just ask David Amick, executive director of Premier Capital Corp., a local lender that uses federal funds to help finance expansions.

"We've got money to lend," he said. "I've got that [message] hung on the door."

The fragile credit markets have nearly diminished the ability of companies to borrow. But lenders such as Amick insist the money is there, if they're willing to search beyond the traditional means.

Some of those might not even involve any type of financial institution or broker. Some are more complex, others more creative.

But just because more options may be available doesn't mean the pace of borrowing is escalating. An economy teetering on a broader downturn is forcing companies to the sidelines while awaiting a turnaround.

Banking veteran Steve Beck launched the local office of suburban Chicago-based Geneva Capital Corp. last year and is hopeful activity will increase.

"There is a lot of non-traditional funding out there," he said, "But I can tell you, it's as difficult a market as I have seen in my 40 years."

For those trudging ahead with projects or developments, here are some choices to consider:

Seller finances purchase

Developers scrambling for cash sometimes will approach the seller of the property about financing the purchase.

The seller assumes risk in the project by providing a deed to the property in exchange for a loan note. From a bank's point of view, for additional financing purposes, the land represents equity for the developer.

The scenario only works, however, if the seller owns the property free and clear. It is used most often for residential projects, when builders typically are buying farmland that has not yet been developed.

Joint ventures

A similar option has the seller of the property becoming a partner in the project rather than a lender.

A developer might give a seller 20 percent of the profit, for instance, in exchange for the land. Yet again, though, the seller must own the property outright.

In larger deals of several million dollars, an institutional investor such as an insurance company or pension fund becomes the equity provider. Instead of providing the money upfront, the investor will do so at the end of construction to induce a lender to provide a permanent loan at a competitive rate. The investor then will furnish the additional funds to secure the loan.

The investor, in turn, will take a percentage of the transaction or a return on its investment.

Mezzanine financing

In this instance, a mezzanine lender loans money to a developer who, in turn, contributes equity to the project. If the project fails, the mezzanine lender takes over the equity of the developer and controls the situation. The mortgage typically will be in default, requiring the mezzanine lender to work this out with the primary lender.

"They step into the very muddy shoes of 'Dan the Developer,'" said Phil Bayt, a partner with the real estate practice group at Ice Miller LLP.

That's what happened in the case of Chris White, the former owner of bankrupt Premier Properties USA Inc. He took out a $41.4 million first mortgage and a $5 million mezzanine loan to buy two office buildings in Woodfield Crossing.

A mezzanine loan is a more expensive financing source. To compensate for the increased risk, mezzanine debt holders will require higher interest rates for their investment-typically 15 percent to 20 percent. Those rates are a strong inducement to pay the loans off quicker.

Private-equity syndications

Taking a page from the 1980s, developers are rediscovering private-equity syndications. Here, individual investors pool together to fund a project, so developers don't need to rely on one source of income.

That is a common way to raise venture capital but has not been used by local developers for years.

Wealthy individuals are solicited to par- ticipate through a private-placement offering. Michael Fritton, a principal at locally based Somerset CPAs PC who leads the firm's real estate practice, helps clients evaluate the offerings.

He's reviewed more of them lately, although private placements can create a dilemma for clients, he admitted. While they might be attracted to a deal, the market turmoil that has pounded their portfolios may keep them from investing, or at least at the level they would have preferred.

More equity required

If traditional banks are lending, they've tightened the grip on how much they'll hand over. A typical loan-to-value ratio of 80 percent has dipped to between 60 percent and 65 percent, ultimately causing the investment a developer has in a project to drop.

If a bank lends $800,000 for a $1 million project that generates $100,000 annually, that equates to a 50-percent cash return for the owner who committed $200,000.

But if the bank will lend only $700,000 and the owner has to commit $300,000 on a project that generates $100,000, the return drops to 33 percent. That forces developers to produce additional equity or limits the number of projects they can undertake.

Banks on Main Street want consumers to know they're still offering loans, by avoiding the disastrous path of subprime lending. Although national banks have restricted lending, their smaller counterparts have not, Fritton at Somerset said.

"It's odd to say the small banks are alternative sources of financing," he said, "but the alternative is that the larger banks are more limited in what they can do."

So, for those lacking the resources to try anything too unconventional, there are still brokers and lenders that channel funds from a stable of banks.

Banking veterans Drew Habib and Darren Hainley started Trademark Commercial Lending last year and have been involved in $300 million worth of commercial loans.

"The banks say no and we say we'll try," Habib said.

Still, these are times unseen in a generation. Bayt at Ice Miller became a lawyer in 1980, when the prime interest rate was 17 percent. Credit was available then, but no one could afford it, he said.

In 1989, other lenders were willing to step in to write down a bad loan. That's not the case now, Bayt said.

"Today, there is no Lender B," he said. "That's the problem."
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