Chapter Four of “The Champion Way™”

By Champion in : Chapter Four, The Champion Way™ // Apr 28 2010

I can’t find the loan I need!

In the real-estate-development industry, there are several absolutes.

If you can ask almost anybody what in the key to a good real estate development project, they will answer with “location”. In fact, they say “location, location, location”. While a good location is by all means necessary, it is by no means the driving force behind the project.

In fact, once location is chosen, the dynamics become even more detailed and important. The fixed dynamic is timing. You can have the best location in the world, but if you are going into a period where banks are cutting back on their lending programs, location is irrelevant.

So while timing is important, the most important thing is the level of activity that lending institutions are undergoing at that point in time.

As the economy passed through (highly successfully) 9-11, it had a robust nature that actually became too robust. It overheated, probably as a reaction to Americans’ desire to put the horrendous 9-11 experience behind us. In doing so, however, they created an entirely new set of problems.

The overreaction hit the housing industry with the housing companies believing they could capitalize on the massive desire of people to move into new homes. Like all overheated markets, it must come to an end. When it came to an end for a very large series of reasons, the banking industry was affected. Most people will say that it was affected mostly because of the sub prime market. The sub prime market resulted in a very small portion of the problem. That is for another writer at a different time to explain.

In Champion, we faced a situation where Champion had grown much faster than its liquidity support in a circumstance where the banks were no longer readily lending funds on well-located and timely projects. We needed to find a mechanism to overcome that in what would be considered “bad times”.

After several months of realizing that day-by-day it was becoming harder and harder to put reasonably well levered loans on good location projects, I came to realize that we were approaching the lenders (while in a conventional way) not in a way in which they could respond at all to our needs.

Typically, we would meet with one or two lenders and provide them with a package of materials which assumed a loan would be granted on the terms we requested and provided them with everything they needed in order to underwrite the loan, get the loan approved through their various committees, document the loan internally or through lawyers and present us with loan documents for signature so we could record the security in favor of the bank and start construction knowing we had more than sufficient funds between the bank’s loan and our own equity to complete the project.

Throughout this entire period, there really was not an issue of equity so long as we had the loans in place, equity was available in the marketplace on terms that were more than satisfactory for us to continue and do well with the projects.

Then one day I realized that we were setting ourselves up for the lenders to say no. This is when I came back from a Strategic Coach™ session (March 2008) and developed the Champion Yes Strategy™. That Champion Yes Strategy™ touted me the ammunition and the process to approach lenders in a very different way – to determine what the lenders’ needs were. After questioning several of our lenders (many of whom had previously said no) I needed to determine their specific needs at that point in time. Listing those needs as of the early part of 2008 would only serve to potentially stymie the same decision that will have to be made in later years, but I do so only as a matter of record. The key needs of the lenders were the knowledge that should the project be delayed for any reason, there was sufficient support, “guaranteed” to the lender that the developer had the strength to carry the project through to completion no matter how much time it took to complete.

We did not have to worry in our projects about the major costs to the project. In every case our cost of land was known, our hard costs were under contract with reputable and stable contractors and our soft costs were largely already paid. In every case, we had building permits and serious pre-leasing and pre-sales already in place. The lender’s concern was not whether we could construct the property on time and on budget, but whether our sales and leasing programs would match the time tables of the loan term and would be completed prior to the expiration of the loan and the requirement for repayment.

Our Lender’s Yes Strategy™ was almost the antithesis of our previous program. We worked with our lenders to determine what they did with all of our information when they received and what were the very few things they looked at to make their initial decision that they wanted to proceed. Through one of my good friends (who is in the banking business) Randy Heller, we developed a single sheet that presented the project and answered on that sheet all of the issues relative to the numbers including what permanent loan could be placed on the project at the end of the construction loan term to assure the construction lender could be paid off.

The problem is that in 2008, the assurance that a permanent loan of any kind was available at that time or in the future was small. The permanent loan market had itself gone into disarray. Therefore, a critical need of the construction lender either could not be met, or forced a construction loan so small that few, if any, could arrange the equity for the project.

Equity funds for a project come at a higher price than do loans. Our loans are paid for by a market-based interest rate. Those interest rates were based off of indexes whether it is the prime rate or the London International Bank Overnight Rate (LIBOR). Typically we would pay one percent over the prime rate or between 1.9 and 2.25 percent above the LIBOR rate. Due to the bank’s cost of money and their risk reward ratios, the LIBOR rate was increased by approximately one percentage point. That is not the problem. Equity money attracts between a nine and an eleven percent interest rate, but comes with providing the equity partner with anywhere between forty and sixty percent of the profit as well.

The Lenders Yes Strategy™ involves recognizing each of the items noted above, and then, providing to the lender one additional assurance – that should the project leasing or sales take longer than is expected, that Champion had the “guaranteed” support behind it to assure that interest payments would be made until the project was stabilized and could be sold or refinanced in even difficult lending times.