pw, all very logical questions. Indeed, how does this situation come about? One word: Competition.
I’ll elaborate.
Six+ years ago if Bill Developer wanted a loan from Joe Banker, Bill had to put up 20% equity, a personal guarantee, limit his own developer fees and offer up a very detailed absorption (sales) schedule, etc. etc. But as more and more potential projects sprouted up, and as competition got really stiff on plain vanilla CRE loans (the bread and butter for local lenders), banks started into the construction lending arena barrells a blazin’, and started relaxing terms and covenants for construction loans such that by 2005 the underwriting was a joke. As of 2005 the typical construction loan required just 10% equity, no personal guarantee, no material limitation regarding developer fees, etc. Basically, competition for the loans led to crappy underwriting. Now, just as in the SFR market, construction underwriting is returning to something resembling the prudence of yore. The problem, of course, is that – as usual – the barn door is being shut long after the horses have crossed the Canadian border.
What are the criteria for developers? Well, there is an appraisal. These are of varying quality. As I explained, the developer does have to put up equity, although that percentage hit is trough in 2005. Other than these purely financial issues, the experience of the borrower is probably the most critical issue. If the developer has a lot of successful projects it can point to, it helps a lot. The problem is that there are a LOT of developers – especially here in SoCal – that have nine financial lives. They did a few good projects in the late-80s then blew up in the 90s. Then they re-invented themselves and did some good projects in the late-90s and early-2000s and now they’ll blow up their bankers again. Then they’ll be back to the trough in about five years to do it all over again… sad but true. Memories tend to be very short in the financial world. Just look at the stock market.
