Staying Afloat: Financing Strategies for 4 Project Phases

WAY Capital's Malcolm Davies on how multifamily developers can obtain funding during this difficult point in the cycle.

Malcolm Davies
Malcolm Davies

While “stay alive ‘til 2025” may have become the commercial real estate mantra of 2024, many multifamily owners, developers and operators need solutions now. A tough market requires creative capital strategies.

Those strategies differ for each phase of a project. Four project phases account for the bulk of financing pickles currently.

I. Capitalizing multifamily ground-up development

Rising interest rates, increasing development costs and operating expenses, softening rental rates and cap rate escalations have made lenders wary. Financing for ground-up multifamily development has become tough to secure in most major markets.

As a result, multifamily construction starts have significantly decreased. Perhaps ironically, herein lies the opportunity.

If positioned correctly, a developer can make the case to both their debt and equity partners that if they can get a shovel in the ground now, they will have one of the few projects that delivers in 2026. At that time, there will be limited competition, but job growth and demographic assumptions will remain largely unchanged.  If they are building in an area with job growth, they will find tenants to fill their new property. 


2. Accounting for escalating costs during construction

Spikes in the price of lumber or steel? Labor shortages? Every seasoned developer knows surprises can be found around every corner.

When the initial construction loan is no longer adequate to cover the escalating cost of construction, project sponsors want non-dilutive ways to raise additional capital.

It’s a very nuanced form of financing but consider mid-stream construction refinancing in this situation. For example, a project is over 70 percent complete, but the developer is experiencing significant cost increases that their lender is looking to them to cover. In this situation, they are required to contribute the overage from either themselves or through their equity partners.

Mid-stream construction lenders can help. These lenders are willing to increase the proceeds of their financing to not only refinance out of the existing construction loan, but also to provide the increased funds necessary to complete the project in a non-dilutive structure. While the project will now cost more, not having to raise additional equity is a win and far less expensive.

3. Paying off an expensive construction loan prior to significant leasing

One very important strategy in today’s market is refinancing upon Certificate of Occupancy. It’s best to start this process four to six months away from project completion and to close immediately upon receipt of the C of O. Take advantage of this option while stabilizing the project since the pricing will likely be somewhere between 200 to 400 basis points cheaper than the construction loan.

Additionally, since the developer is still selling off of projections, it’s likely a better option to close that refinance prior to determining the actual market figures. If the developer waits a couple of months past the C of O and the project isn’t hitting its projections, they will likely find themself with a more expensive loan and less proceeds.

Currently, bridge to agency lenders, life insurance companies, banks, credit unions and private debt funds are providing this kind of loan. Stabilized, affordable housing projects may be able to access even better terms.

4. Overcoming a sluggish lease up

What happens if lease-up rates are less and slower than the developer anticipated? Most multifamily construction loans have a three-year term with extension tests that likely will not be met in this scenario.

These loans usually allow for two years of construction and one year of lease up. In situations where the developer is faced with a loan maturity and a partially leased property, many lenders will require the borrower to post deposits to cover interest costs as well as ‘pay down’ the loan to qualify for the extension.

If the borrower cannot do either and a full refinance, as referenced above, is not feasible, then bringing in preferred equity, participating preferred or even common equity can help gain time to stabilize the property. These options are the most expensive but are better than handing the keys back to the lender.

It’s important to know where the property value sits in this situation. A general rule is that if the property is 80-85 percent loan-to-value, new capital can provide the necessary liquidity. The capital can be from preferred equity or mezzanine financing and will be non-dilutive to the equity (other than the fixed cost of this financing).

Anything above 85-90 percent will require participating preferred, a situation where the new capital receives a priority return of its capital, and on its capital, ahead of the existing equity shareholders.

If the LTV sits at 95-100 percent of the LTV, the developer needs to pursue a common equity recap. This is dilutive to the existing shareholders and will generally take more time but is better than selling the property and either taking a loss or simply returning the equity invested in the project without a profit. 

These are challenging times, requiring thoughtful solutions that, while not perfect in all circumstances, are certainly better than the alternative.

Malcolm Davies is founder & CEO of WAY Capital.

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