The 3 C’s of Negotiating Construction Loans

Parkview Financial's Himanshu Tiwari on the current pain points for lenders.

Himanshu Tiwari

As we move into a more challenging lending environment, more transactions are dying in negotiations as developers strive for better business terms and lenders tighten up their underwriting guidelines. It’s a frustrating situation for everyone.

Our team believes that successful negotiations require a deep understanding of each party’s needs and concerns. Reciprocally, developers and brokers should both understand the pain points for lenders, and why they are sensitive about certain things.

Lenders are primarily concerned about their potential losses or downside. To ensure their loan will get paid back, underwriters are concerned about the Three Cs of Credit: Character, Capacity, and Collateral, which are expanded on below.

1. Character 

Lenders consider the character of the borrower, meaning they check out the borrower’s credit history, background, and reputation to see if there are any red flags that might indicate a higher risk of default. If there are any concerns, the lender may require additional checks and stipulations to avoid potential issues down the road. Understanding and pursuing a lender in line with the borrower’s character should be done early on to avoid any last-minute heartburn due to a mismatch.

2. Capacity

Upon evaluation of the sponsor’s capacity to repay the loan, lenders estimate their comfort level of the maximum loan amount. This is an assessment of the amount the sponsor can pay out of pocket should there be a default. This is often assessed through the financial statements of the sponsor and might require stipulating specific leverage and liquidity. This is tackled by limiting the loan and by requiring additional and upfront equity infusion from the project.

3. Collateral

Lenders assess the collateral being offered as security for the loan. This is especially important for construction loans, which are typically non-recourse with bad boy carve outs. That means that, if there is default, the lender only has recourse to the underlying collateral property, unless the sponsor acted in bad faith. This creates a special challenge for construction loans as the assessment is not only based on the current status of the property but also involves estimates of the future value of the collateral, which is highly subjective and is often an issue of contention.

In addition to the Three Cs, lenders use financial metrics such as loan-to-cost, loan-to-value, debt service coverage ratio, and debt yield to evaluate the overall risk of the transaction. In line with the assessment of Three Cs, lenders require specific values for the financial parameters. These metrics constitute an important part of the negotiations and the involved parties’ expectations must converge on these parameters.

As a lender, we know that it is always important to keep communication open and transparent, so that we can address a borrower’s needs and concerns effectively. It is critical to thoroughly discuss requirements and explain the reasoning behind lending decisions using the metrics discussed above.

As a developer or broker, starting a negotiation with an awareness of how a lender will view the transaction, and an honest assessment of strengths and weaknesses from a lender’s point of view will greatly increase a borrower’s chances at closing with favorable terms, which is the need of the hour. Furthermore, it will make the process more pleasant and profitable for everyone.

Himanshu Tiwari is an underwriter at Parkview Financial.

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