Who is financing development and how? : a survey of the 100 largest projects in the U.S.

Abstract

In response to huge losses incurred from real estate investments, private capital withdrew from the market in the early 1990's, creating severe illiquidity. Wall Street, recognizing this lack of capital presented a potential arbitrage opportunity, began to issue public debt and equity securities to finance real estate. Many believe that this introduction of the public market to real estate will impose increased discipline on the suppliers of capital; potentially reducing the probability of overbuilding. The purpose of this paper is to briefly discuss the causes of past real estate cycles and, based on a survey of current construction financing activity, to comment on the current trends in the credit markets. The primary research for this paper, the construction financing survey, was designed to provide, from the perspective of the real estate developer, a snapshot of the loan terms currently being offered in the market. The owners of each of one hundred of the largest retail, office, multifamily, hotel and mixed-use development projects in the U.S. were contacted and questioned regarding their recent experience in securing both construction and permanent financing. The results of the study were interpreted to determine the dominant suppliers of construction and permanent financing and the level of discipline being exhibited by the credit market in general. Of particular interest was the availability and pricing of capital to fund new construction, current underwriting practices and ultimate exit strategy of the developer. The results of the study confirm that heightened competition between a wide variety of capital market participants has resulted in favorable pricing, an elimination or significant reduction in pre-leasing, equity and guaranty requirements and an overwhelming absence of takeout financing. Furthermore, despite the recent decline in stock prices and acquisition activity, developers continue to rely on REITs to provide an exit strategy for new development. Therefore, the strength of capital market and the eternal optimism being exhibited on the part of developers and lenders seems to suggest a growing potential for future oversupply.