Ask me anything about...Construction.

[Meryl McElwain]

I always see posts from investors asking about the cost of a rehab, a particular estimate or a general construction problem. I have 20 years of construction experience. From remodels, ground up, all the way to developments. 

Ask me anything.

[Meryl McElwain]

Originally posted by @Adam Fiore:

@Meryl McElwain

How did you get into Sub divisions ?

Was this a natural

Progression?

How did you go about securing financing ?

Part 1 of 2

 Subdivisions are pretty much always a natural progression for a builder.  Just like investors work really hard to get to the point where they can buy rental properties without borrowing-developers are generally builders first who just wanted to get to the point where they could finance their own deals. So I would yes, it's a natural progression for some.

How do you go about securing financing? The answer depends on the animal.

 Development loans are generally done in 2 to 3 parts.

1. The acquisition loan, if any

This is the purchase of the property

2. The site loan

I call this pre-asset construction which just means the invisible work.  The work that has to be done before the bank will have anything tangible to sell in the event you default.  It's higher risk.  This is everything from engineering, architectural plans, road installation, utility installation, mass excavation, street lights, ancillary parking, lawyer fees, village hearing fees.

3. The construction contract

This is your actual cost of construction on let's say 16 units.  It's estimated by a contractor's statement.  Some guys estimate the whole project on one sheet.  If you want to do it correctly, each unit gets a K statement.  Why? because each property has it's own legal description, tax pin, and lien rights.  If you do one K statement and you get one sub that didn't get paid for tile on Unit 14 filing a lien on a single tax pin that gets recorded on all 16 of your units.

So let's say you find a piece of raw land. It's five acres. It's priced at 5 million. A million an acre. Unless we're in New York or California that's not going to happen but it'll make my math easy so here we go. Development loans much like normal mortgages have a LTV. It's usually set by regulators and then modified by the banks board. The last one I did was a syndicated bank whose board set the LTV at 78%. That's high. It's usually only 76%.

What is generally expected is that you come into the bank with the land paid for. That's the downstroke for your loan. When you get into the enormous projects that's not always possible but 9/10 times it's expected. Let's say you have a 300 million dollar project and the land is valued at 50 million. Most people don't have that kind of cash on hand. They have to raise it. An experienced developer will have investors. Those investors can't take a first lien because their cash is going to cover the down on the traditional financing. So they're taking shares. Those shares are either in a REIT or an LLC or they're maybe they're taking condos as payback on the other side. Some kind of arrangement is being made. If I have a 300 million dollar project in mind I'm going to need a million or two of my own to secure the contract on the property that I've probably been assembling piece by piece for at least a year. Then once I get a contract locked down I have to go raise the money for the down with the bank. Or if you're one of those people that laughs at bank financing like it's the joke of the century then you're going to private equity, retirement funds with designated allocations, private money family offices. The latest one I've seen are community activist organizations who have already raised the funds but are looking for a say in the final product you develop. A bank is almost always the cheapest but the amount of due diligence they will put you through is labor some compared to other routes (some say). It's my personal opinion that if you cant make it past bank underwriting you shouldn't be doing this. Reasonable bank underwriting. They're are your over zealous parties but you can generally bypass that by getting to a or THE VP of lending. I can't tell you how many deals I've seen die with a "senior loan officer" who just doesn't get it. There are rules- but even with banks you'd be surprised at how much of comes down to you and one guy across the table who makes the decision. I also think private parties ask and expect the same answers a reputable bank does but that is only my opinion. A ton of people will disagree with me. I once had a client with 25 million in hard assets court ordered to pay 750K in escrow for lawyers fees and he couldn't come up with it. Why? Because he was dramatically over leveraged. Eventually he found a bank to loan out the 750K but the point is the guy had 25 million in real estate and he couldn't scrape together 750K in cash. That's an issue any way you slice it.

Alright so back to it. You need a site loan because the land is shaped like a box. On the north side is 32 homes running on septic and well. On the west side is a public park with tennis courts. On the south side is a development with an HOA. And finally on the east side is Route 44. A major thoroughfare 2 lanes wide on either side.

First thing you need to do is figure out whether your zoned correctly. Assuming you are and you get the village's blessing on your PUD (planned unit development-which is industry speak for subdivision) you need to locate some utilities and get some roads in there. There is a ton that goes into the PUD but a lot of times the primary lender expects you're coming to them with the site work either done or at least you're going to pay for it yourself. Why? Because it's risky. Who wants to be the guy that loans a million bucks to cover site expenses only to find out the builder can't perform and now we (the bank) have nothing to sell to recoup our losses. Again, people will disagree with me on this and say it's completely marketable.

That's going to conclude part 1.  Check back tomorrow for more excruciating details.