Inside Third & Bond: Week 14

We would be remiss in discussing the Third & Bond development without a word from our financing. As noted in our first posting, we had to envision the outline of the entire project before even knowing how much to offer for the land. Part of the vision thing is figuring out the financing. Most land deals do not offer financing contingencies, so once we write that non-refundable deposit check on the land acquisition, we better have a good plan to put all the financing in place. In fact, when we were negotiating with the sellers over the length of the contract since we were all in a huge rush (30 days? 45 days? 60 days?), we had our feelers out to several lenders to determine how fast they could move.

Why a loan, you might ask? It’s not so different than our condo buyers. Probably for starters we don’t have all the money lying around to pay for all the project costs. Even if we did, we wouldn’t want to put all our liquidity eggs in one basket, if it means saving our funds for a rainy day, or leveraging pre-development costs on another project.

We went out looking for $10 million in acquisition and development financing to help fund the land costs as well as pre-construction items from architecture and engineering to the interest on the land loan. Later in the year, we’ll refinance the land loan with a $30 million construction loan which will pay for all the prior costs as well as the construction period hard costs (bricks & mortar) and soft costs (everything else). Read about the key loan terms and an update on the Stop Work Order on the jump…

Whether a land loan or construction loan, we usually boil down the key terms of any loan to the following 5 issues. In the case of our land loan, we agreed to terms with Wachovia Bank. We already have a relationship with Wachovia that dates back to the days when they were First Union Bank. As First Union Bank, they financed an 80/20 rental we developed on West 48th Street (The Clinton), and subsequently Wachovia was the $117 million construction lender on the NYU dormitory we’re building on East 12th Street. In addition, our relationship with loan officer Duane Mutti dates back at least 15 years to the days Duane was providing affordable housing loans to us when he was at Chase. Indeed, the right relationship is everything. So we’ve summarized below the key issues, and where we settled with Wachovia:

Loan Amount
You don’t have to be a blog genius to know that the goal is to get the full amount of the financing you’re seeking. Usually, the loan amount is the lower of the loan amount on the initial term sheet and a percentage of the appraised value, say 70-80%. There’s also the option of getting a second loan to reach the magic number, which is comparable to home owners getting a 2nd more expensive loan for 10-15% of the purchase price. For Third Street, we agreed to a first mortgage loan in the amount of $6 million as well as a 2nd more expensive loan in the amount of $4 million. The second loan is usually called a mezzanine loan, or a B loan, or it can even be a line of credit to the developer.

Interest Rate
Interest rates have 2 components: the loan index such as prime or LIBOR and the bank spread, the amount they charge you over the index to account for their calculated risk. 10 years ago, most real estate loans were prime-based, now they’re all LIBOR based. Today, LIBOR is 4.6% but at the time it was more like 5.3%. Every day or week that the LIBOR rate adjusts, so too does your loan rate. We’ve seen rates as great as LIBOR + 1.35% (also referred to as + 135 basis points) and as high as + 4.00% based on how good the project is, the leverage, the developer’s track record, etc. For Third Street, on our first loan’s rate, we did better than LIBOR plus 200 basis points, and the more expensive second loan is 50 basis points higher than the first loan.

Guarantees
Near and dear to any developer’s heart is limiting their exposure on guarantees to lenders in case the project blows up in their face. For instance, in the case of a $10 million loan, let’s say a dramatic drop in the condo market or new information about a toxic brownfield on the site (that brownstoner postings seem to be obsessed with) renders the site worthless. Do we write a check to Wachovia for the $10 million we owe them? Or do we hand them the keys to the site and say good luck, as a foreclosed homeowner has the ability to do when mortgage balances exceed home values? The amount of our guarantees are heavily negotiated. In the case of Third Street, 25% of the $6 million loan is guaranteed (personally by the 3 Hudson principals) and 100% of the second loan is guaranteed. But, there is a carve-out for environmental liability, so in the case of the brownfield, we would be on the hook for the full $10 million loan.

Loan Fee
As opposed to the no-fee home loan, we’re used to paying a loan fee on all real estate loans, typically priced at .25% – 1% of the loan amount. For Third Street, we’re paying on the low end of the range for the first loan and twice as much on the second loan. See the pattern? Like a homeowner trying to finance 90% of a purchase price instead of 80%, the financing costs increase with the leverage.

Relationship
The last issue is not a dollars and cents one but it is just as important. How is this relationship going to go, especially if there are changes in the project or bad times? How onerous will they be if we want to modify the approved project plan? In one case (in West Chelsea, for our project The Marais), we approached our lender and said we wanted to change the project from a rental to a co-op. Was that hunky dorey? Conversely, the lender is asking these same questions about the borrower.

Hudson has been fortunate to have good relationships with numerous construction lenders including Wachovia, PB Capital & Chase, and the borrower-lender process of sniffing each other out will begin again in earnest in the next 60 days when we seek construction financing.

Stop work update: Exciting times last week at the site when we were digging a new test pit. We filed for the test pit exactly as asked by our contacts at DOB. But then a neighbor was irritated that a jackhammer was outside his house (at 7:45am, long after the 7am allowed start time) and called 311. Since the Best Squad is dedicated to providing inspections anytime anyone calls and it seems to be their charge to try to find something that is a problem, an inspector came out and tried to shut us down. We spent about an hour with him on the phone to his boss while we were on the phone with our expeditor, who was also on the phone with the inspector’s boss. In the end, we finished the first test pit and DOB asked that we resubmit the paperwork per new instructions as well as to build a temporary construction wall between our lot and another of our lots. Again, this is the first time in twenty years we’ve ever heard of getting a permit to do a test pit. What’s next? Getting a permit to bury your goldfish in the backyard?

Inside Third & Bond: Week 13 [Brownstoner]
Inside Third & Bond: Week 12 [Brownstoner]
Inside Third & Bond: Week 11 [Brownstoner]
Inside Third & Bond: Week 10 [Brownstoner]
Inside Third & Bond: Week 9 [Brownstoner]
From our lawyers: This is not an offering. No offering can be made until an offering plan is filed with the Department of Law of the State of New York.”