Financing a Real Estate Development in California

Author: Staff

Real estate investment in California takes many forms. An investor may, for example, simply purchase shares in a real estate investment trust (REIT), or they may contribute to a real estate syndicate. In those cases, the investor entrusts their money to others and does not get directly involved in the development or operation of the real property. Other investors might like to be more involved in the day-to-day workings of a development project. Either way, California real estate investors should have some familiarity with commercial real estate finance. The following is a very general overview, which assumes that the development project involves building a commercial shopping center on unimproved land.

Short-Term and Long-Term Loans

Real estate development typically begins with the construction of improvements and ends with a completed, fully leased facility. This lengthy process might require multiple stages of financing. Commercial loans can be broadly categorized as short- or long-term.

Short-term loans provide capital needed for the construction of the facility, as well as operating costs during the “lease-up” phase. This type of loan might have a comparatively high interest rate and might include a balloon payment. Short-term loans include construction loans, which finance the actual construction costs, and any bridge loans that might be needed during the construction and lease-up phases.

Long-term or “permanent” loans allow the developer to pay off any short-term loans, followed by regular loan payments over a longer time frame.

Types of Commercial Loans

In addition to the short- and long-term distinction, commercial loans can be classified by their purpose:

– Acquisition loans provide capital for the purchase of raw land. This does not apply to developments that use ground leases to obtain property.
– Development loans cover the cost of preparing land for construction. This might include altering the terrain, building roads, and installing utility lines.
– Construction loans, as mentioned earlier, pay for the construction of improvements. In this case, those would be the shopping center buildings.

Commercial Financing Regulations

Developers must be aware of a vast range of laws and regulations, which range from federal finance rules to local regulations about tree removal. One relatively recent development involves the regulation of high volatility commercial real estate (HVCRE). This concept originated with an international banking organization, and it became law in the U.S. through the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010. Regulations implementing the HVCRE rules took effect in 2013.

The HCVRE regulations limit loan amounts for many commercial projects. While each development project could be affected differently, the HCVRE rules frequently cap commercial loans at 80 percent of the project’s estimated value upon completion. They also often require that at least 15 percent of the total value come from equity, which includes contributions from investors.

Creating a Financing Strategy

Preparing a strategy for financing a development project depends on the nature of the project and its location, among many factors. Large commercial banks can provide long-term permanent loans, but local and regional lenders might be the best option for short-term loans, since they are likely to know the economic conditions of the area.

There are no templates that fit all projects, but ideally, a developer begins by obtaining a permanent loan commitment, followed by a development loan, if needed, and a construction loan. Once the project is built and leased, they can close on the permanent loan and pay off the short-term loans.

More Blog Posts:

How Dodd-Frank Has Affected Hard-Money Lending for California Real Estate Investors, Titles and Deeds, October 18, 2017

Hard Money Lending for California Real Estate Investments, Titles and Deeds, October 5, 2017

Real Estate Financing for California Real Estate Investors, Titles and Deeds, August 17, 2017

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