Selecting the right construction lender for your student housing project is often as important as choosing the right contractor, leasing manager and rental rates for your property. Closing and construction delays that cause a missed opening date can drastically reduce returns and stigmatize a project that can take years to overcome.
The borrowing market is very attractive right now, with lenders lining up to lend money for a quality project. However, as we all know, this business is cyclical and there will be a time, typically sooner than the market thinks, when a developer needs a lender to act like a partner too. Because of that, it’s important for the lender to not try to squeeze the last basis point out of a loan spread or upfront fee, but work with the developer as a long term client. Construction loans need to work for both parties, the borrower and the lender. This will pay off for developers in the long term. Stonemont Financial Group always makes sure to treat its lenders as partners.
There are a few things that developers need to focus on when selecting a lender: does the lender work specifically in the student housing industry? What is their approach to the closing process? Are you both on the same page when it comes to the nitty-gritty details, and what are the lenders monitoring and reporting requirements?
Do your homework on a lender
There are many lenders out there willing to work with you, but the question you need to ask is do they have experience lending in student housing projects? Many lenders entering the market today are coming out of the multifamily sector. While similar, opening on time is much more important in the student housing business. A lender should understand that.
It’s also important to note that lenders are most comfortable providing capital on projects where the bank has a geographical presence. If they do not, there could be unforeseen surprises that can come up when the lender goes up the chain to the credit committee.
If it is a first time lender for you, ask for references. You should be looking for any surprises that others may have seen during the closing process and funding during construction. A developer needs to do their due diligence on the lender as much as the lender will do on the developer. Ask about how they have dealt with delayed projects in the past. In their answer, be sure to look for a desire from them to work with their borrower in the case of unforeseen delays.
The closing process is vital. A lender should provide a full due-diligence list early on in the closing process. In addition to traditional real estate due diligence (appraisal, environmental, survey, etc.), this should include business items, such as property pro forma. Most banks today have to order an appraiser in-house, rather than accepting one provided by the borrower. It is important to understand the timing of this, as well as insuring they use nationally known appraisal firms that understand the student housing business.
Make sure you both are on the same page
Do they agree with your pro forma? It is in a developer’s interest to show the lender a pro forma with “stressed” NOI, including rents about 10 percent lower than expectations, a reasonable vacancy assumption and more than sufficient property reserves. Lenders will size the loan based on a debt yield (property NOI divided by loan amount), typically looking for between 8 and 9.5 percent. If you can achieve their desired yield on this “stressed” pro forma, you will sleep much better during the lease-up period, allowing you to focus on an on-time delivery.
Do they agree with the construction budget? In addition to your known hard and soft costs, be sure to include a sufficient contingency, typically around 4 percent of costs. It is also important to know that if the project comes in under budget, will your lender allow you to draw down the rest of the committed loan amount? A good relationship lender will allow you to fund the rest of the loan to get a head start on project-related items such as operating reserves or capital reserves.
What is the required recourse? It is typical for the developer to provide recourse during construction. However, the amount of recourse should reduce upon issuance of a certificate of occupancy and hopefully be eliminated upon project stabilization (as measured by stabilized debt yield).
Monitoring process and reporting requirements
Most lenders will contract with a third party to visit the site monthly to ensure progress and sign off on construction draws. This should be a nationally known firm with the resources to guarantee timely inspection and sign off. You need to understand exactly what they are looking for on their inspection. This third party will also need to sign off on the initial construction budget to ensure it is sufficient to complete the project on time.
Most lenders also have reporting requirements. One report will be during the construction period and should just be their third party inspector report. The second is post-construction, which should include property financials and guarantor financials.
In selecting the right lender, start with your existing relationships. If none of your existing relationships seem right for the market or they do not have student housing experience, ask them for references. If you need to go to a new lender, start with well-capitalized banks in the market where you are developing — again, banks like to lend in markets where they have a presence. If you can begin with a reference from one of your existing lenders, that will put the banker at ease on a first call.
— Brice Willis is the vice president, capital markets, of Stonemont Financial Group, a national real estate investment firm specializing in providing capital for single-tenant build-to-suit developments and sale-leasebacks, as well as student housing investments.