The Stages of Construction Financing – Creating Value for Borrowers and Investors at Every Step
Real estate projects are completed in stages, and each stage of the construction process can be financed separately. In this article, we will explore the different stages of real estate development and how appropriate financing can add significant value at every stage. Identifying these details is critical to understanding how Broadmark Realty Capital (“Broadmark”) (NYSE: BRMK) participates in the real estate construction process, as well as the significant market opportunity and demand that exist for our suite of products.
Broadmark is a real estate lender that specializes in financing for builders and developers who require quick closings and outside-the-box thinking. Broadmark employs conservative underwriting guidelines to protect investor capital, and provides creative and flexible financing packages allowing borrowers to quickly capitalize on market opportunities.
Raw Land Acquisition
Raw land acquisition refers to the purchase of a plot of land that does not have the necessary permits or “entitlements” in place for construction. Examples of raw land are an infill lot in a dense, urban location, or land in a suburban area that can be divided or “platted” into individual lots to build multiple structures. Raw land can also include rural plots, although Broadmark typically does not lend against this type of asset.
A key factor in determining the risks of purchasing raw land is the marketability of the land and the completed project. Some lenders consider themselves “land banks,” and specialize in funding the purchase of raw land before the profitability of a project is determined, adding to the risk associated with the loan. Broadmark is not a “land bank”.
Broadmark will participate in raw land acquisition with certain requirements in place. Typically, this includes evidence of feasibility work and/or cross-collateralization of other properties. A path to entitlement must be clear. Broadmark will also consider the ability of the borrower to obtain financing for future stages of development.
Horizontal development refers to obtaining entitlements and adding infrastructure to prepare a piece of land for vertical construction. This can include finalizing permits, installing utilities or laying a concrete pad. Generally speaking, a horizontal development loan will include a combination of these elements.
A primary risk associated with horizontal development loans is overleveraging. Often, borrowers borrow too much against the land, leaving them without access to the capital that is required to move a project into its next phase (vertical construction). This can make it impossible for the borrower to refinance or secure a vertical construction loan without putting up a significant amount of additional equity.
Broadmark mitigates this risk and prevents disruption to the construction process by underwriting the vertical phase of construction along with the horizontal phase, ensuring there is enough equity for vertical construction without requiring the borrower to raise additional capital. This allows the borrower to refinance with another lender, if desired. However, in many cases Broadmark will also lend on the project’s vertical construction phase.
The vertical construction phase entails the actual construction of the structure. It can involve a variety of asset types, including single-family homes, apartment buildings, townhomes or condominium complexes.
Broadmark holds back most of the loan for construction draws and releases funds after the scheduled portion of construction has been completed and verified by an inspector. If necessary, lien releases from sub-contractors can also be obtained. In the case a borrower cannot complete construction, Broadmark has the funds, plans, clear title and expertise to complete the project. This minimizes risk for the lender and investors while providing the borrower with the funds needed at each stage of construction.
Once a project is complete, and before its full profitability has been realized, financing is often needed for “stabilization”. For an apartment building, this means having a certain percentage of units leased or occupied. Stabilization is typically required to qualify a property for permanent financing that will carry it throughout its lifecycle. The primary risk to the post-construction lender is realized if the borrower cannot lease the property and refinance, in which case the lender may take back a completed investment property. Historically Broadmark has not financed these types of “bridge” loans but may consider originating more in the future. Rates on these bridge loans tend to be lower, as the perceived risk of lending on a completed project is lower than lending on a project under construction. However, these bridge loans represent an opportunity for Broadmark to provide borrowers with a complete suite of financing options from the start of the project through stabilization.
As we’ve demonstrated, providing financing at multiple stages of the development process is a critical component to Broadmark’s investment strategy. Our practices help borrowers advance their business plans successfully and efficiently, while protecting investors and generating risk-mitigated returns that meet their investment goals.