When is land loan retired in a development project?

Question

Let's assume I'm doing a ground up development project and I have a loan for land I'm developing. Assume the exit strategy and end goal is develop the land, build a multi unit apartment complex,  lease up, and sell it for a profit.

Is the land loan retired by the construction loan? Or does the permanent financing essentially pay off both land and construction loan balance? Or do you carry that land loan until you sell the property and pay off all debt with proceeds of the sale?

Trying to wrap my head around the real estate finance cycle. I'm reading some college textbooks, but sometimes they don't address the finer points.

Thanks for any input you can provide.

Travis

Jay Hinrichs · Answer

the last few post are talking about seller subordination.. in a flat market that can work in a stimulated or growing market your going to have a hard time getting a seller to do that.

one there are tax implications that need to be thought out by the seller.

How we do it is pretty straight forward.

last deal went like this.

Raw dirt 500k plus 100k to get it to prelim plat  we pay cash for all of that no debt no loan.

1 million to improve it to shovel ready... we borrow that in first position..

23 improved lots appraised for 2,990,000  bank loan 1 mil or  33% of ra dirt.. you can squeeze sometimes and get a bank to go 50%  they did give us the 100k on the first draw for our soft costs

now we get vertical loans of 240 k or so to build the homes  plus 60k for the lots or about 300k.. so new loan for 300k.

this loan retires the banks horizontal loan.. and we own the last 5 lots free and clear since we are paying an accelerated  pay down.. houses selling for 450k   so right at a 70% ARV loan on new construction which is about where they like to be.

now our loans are a tad higher because we put in 10k fluff and 10k interest reserves.. so as we build out we do not have any monthly payments.. so in theory we got interest reserve on the horizontal loan and we have interest reserve backed into the vertical.. so we did this all with ONLY 600k in cash.. profit a little over 2 million end of the day in about 26 months total..  not sure what the return is I never bother to run the math but I know we are making some nice profit here.

although lumber sky rocketed and I bet we will pay 200k out of our 2 million in lumber over runs.. OUCH.

Karen Margrave · Answer

If you're borrowing money to buy the land, that lender would be holding a note, secured by a 1st Deed of Trust. Most lenders on land won't loan more than 50% of value. Any money that you borrow for development/construction would then have a note secured by a 2nd Deed of Trust (and most construcitons lenders won't take 2nd position). However; it is possible to get the lender on the land to subordinate to the Construction loan (sometimes). However; it's very rare to get that if you don't have any kind of track record, as they are gambling that you're going to get a construciton loan and be able to build the project at the price you say you can, and finish it in the time frame. If you have miscalculated the costs and cannot finish, nor pay them off, their recourse is to foreclose on the project, meaning they would have to be in a position to pay off the construction lender and have the funds to finish the project and put on the market. In addition, it's extremely difficult to find contractors to come in and finish a partially completed project, as it disrupts lien rights, etc.

So in answer to your question, more than likely for an inexperienced builder, you will need to buy the land and hold free and clear, and then use that for security for your construction loan.

Jeff Kehl · Answer

@Travis H. I'm not sure which podcast, but the other day I heard a great strategy for this. The current owner/seller is your best holder of the note on the land and make sure it will be subordinated to a future construction loan.

And if that doesn't work, they are your best equity partner, just give them an equity position equal to the value of the land in the development llc or partial cash/partial equity.

Most property owners want to just cash out and get their money but that land is worth far more in a development scenario so I suspect many landowners would agree to cut some kind of deal like that.

And it's short-term, they just need to hold a note or equity for a year or two until the construction is complete and then they cash-out.

Joel Owens · Answer

What a bank or lender will agree to with structure varies. If you have an actual project you could approach the local banks and ask questions on what the requirements would be.

I know someone who used to develop in Colorado for retail centers. The entitlement and approval process is very long compared to other states so for some developers they find it to burdensome and pulled out of the market.

Travis H. · Answer

@Jeff Kehl - I actually read something similar in the textbook I'm reading now as a good strategy for cash strapped developers. They simply called it a form of seller financing or a mortgage purchase agreement with the seller. Good to hear some real world validation that it's an option. It stated in those instances where a seller agrees to seller financing and subordinate to 2nd position for a construction loan they may command a higher price or return due to increased risk.

I love the suggestion Jeff Kehl. Thanks for the comment.

Travis H. · Answer

All very helpful answers. Thank you especially @Karen Margrave. I would fall into the class of experienced builders so I would assume buying the land and holding free and clear would be the path. Sounds like if I either have enough cash myself or am able to raise enough equity partners than the challenge of getting the construction load in 1st position is feasible.

When is land loan retired in a development project?

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