Non-Recourse Construction Loans

Prior to the advent of Internet-based programs, non-recourse construction loans were - by and large - the province of the federal government that provided tax-exempt bond financing and mortgage loan insurance for certain types of commercial income-producing properties and lines of business.  Today, non-recourse construction loans can be obtained by increasing the amount of at-risk equity contributions to the transaction - the sufficiency of which provides enough financial incentive for a lender to provide non-recourse construction financing.

Increasing the equity capitalization is just one of the solutions for obtaining non-recourse construction loans.  In fact, there are a basket of transaction terms that can be modified to induce a lender to make the construction loan, including:

• Increases in the interest rate the notes bear; and

• Increases in the origination and placement fees/points on the note; and

• Posting additional collateral (not a smart option, but it is one that works); and

• Creating a condominium ownership plan for a portion of the property and immediately applying the sales proceeds against the outstanding indebtedness; and

• Creating a tenants-in-common fractional real estate ownership interest syndication to provide near-term equity contributions that reduce the loan (per the heading of this page).

Ultimately, these items are used in combination to make the transaction attractive to the lender.  In many cases, the reduction in the origination fees (created by the reduction in the origination amount of the loan) can be waived and the points increased the same dollar amount as if the higher loan-to-cost ratio had been used.

The secret lies in the analysis of the transaction parameters to answer the following key questions:

• What is the unleveraged hurdle rate the transaction is expected to generate?  This is an important matter, because if the transaction cannot provide a hurdle rate that is higher than the interest rate on the loan, then the transaction will no longer be a supportable transaction and the lender won't lend no matter what the deal provides.

• What is the leveraged equity return hurdle rate?  The leveraged rate is what most people focus on, but it is not the only measure.  The more important measure (above) is the unleveraged rate.

• What is the total projected equity gain once construction is complete and the project has been stabilized at its maximum economic operating capacity?  This is very important because the construction risk syndicate investors (who will be providing at-risk capital contributions of cash for the deal) will be provided for mainly from this gain.  Yes, it is shared with the developer, but the larger the share going to the developer, the more likely it will be that the transaction will no longer work.

Continued on the following page.