The Art Of Construction Loans With Expensive Dirt

It has been a while since I had the time to blog so I figured I would give it a shot to dust off my writing skills a bit during the long holiday. 2013 has been an unbelievably busy year and I am hoping 2014 will be even busier.

This year we have learned to perfect our pitch to construction lenders. Financing for specs loosened up quite a bit this year after pretty much grinding to a halt after the mortgage crisis. Banks seemed to slow lending a bit around the time the government had a threatened shutdown. Other than that the market for construction loans in the Austin area is getting much better.

Several of our target zip codes for new construction and land development have fairly expensive dirt. The value of the land is often 40% or more of the overall value of the project after the improvements are finalized. We operate on about 30% gross margins with our projects so the C is the constraint when the standard cost and value ratios are used for lending decisions. The market demands that we pay cash for dirt or we'll lose out to other investors in almost all circumstances. This present an interesting challenge for getting the largest amount of the capital stack possible in debt on these projects since it is cheaper than equity.

Banks often don't want to marginalize their security interest and thus are not very enthusiastic about doing a cash-out refinance so that we can advance the first part of construction keeping a 80% LTC constraint in place at our construction closing which generally is months after the land purchase. We have, however, been pretty successful with convincing the banks to advance the first part of the construction instead of paying solely on completed work.

What frequently happens is that the person underwriting the loan is a different person than the one issuing the draws during the project. Thus it presents operational challenges for the person funding the draws because they have to deviate from their general policy of only advancing money after work is completed. We have to pair the two bank folks together to get the money unclogged. We also take painstaking care to make sure that it is abundantly clear that we wish for the bank to advance the first draw and get things in writing. We had some episodes earlier this year where it was fortunate that things were in writing via email because the lenders conveniently "forgot" about what we had agreed to after the project was in flight.