It is either impossible or very difficult to obtain a bank loan to build a new commercial real estate development. Banks fear collapse of the commercial real estate market. Many banks remember that they collapsed or nearly collapsed from the disintegration of the residential real estate market.
In addition, commercial real estate rents have fallen. Vacancies in commercial real estate have increased.
Is there any type commercial real estate in demand? Several! First, there are existing commercial real estate that have loans that are expiring. The owners of these developments are finding it equally difficult to refinance these existing developments. The same is true of potential buyers of these developments not being able to finance the purchase, thus making it very difficult to sell these existing developments. Many of these buildings need work- with no funding of loans available- no needed work being done. Secondly, there is a demand for new mixed use developments that include residential, commercial, and entertainment.
Many banks that were large construction lenders for real estate, are not making any loans. They are saying that the earliest they will even look at new loans is the second quarter of 2010.
Meanwhile governments and other groups, are demanding all new or rehab construction meet L.E.E.D. standards.
I think in the next few years commercial real estate loans will be 75% or less of cost. In the last building boom loans were at 80% to 85% of cost. Despite the Fed keeping down interest rates, commercial loan interest rates will be higher. So if a building cost $1 million, the developer could loan $850,000. Now with the lower loan to value and the increase in interest rates- the developer will probably be lucky to get a $700,000 loan.
This doubles the equity required to be raised from $150,000 to $300,000. If the building was projected to have a cash flow of $20,000 per year for the first five years, and the investors received 70% of the cash flow. With the lower equity requirement- the investors would receive a 9.3% annual return. With the higher equity requirements, the investor’s return is only 4.6%- hardly a rate that will attract capital. One of the solutions is to cut the development budget. This means that we will not be able to add anything to the building specifications. UNLESS, we can substantially lower the operating costs enough to substantially increase the cash flow. Do not forget the 30% tax credit for alternate energy systems.
This what architects, engineers, and contractors should be working on in their now spare time. Next year, clients will come into your offices wanting to develop commercial properties faced with problems similar to the foregoing example. They have a budget and are having difficulty meeting the local L.E.E.D. requirements. Their bigger problem is raising equity capital.
You wave your hands – abra cadabra – you may have the answers to their problems. You will have to work on the design of their building to see if your solution is feasible for their project. You can not do this on a contingency. They have to invest in your work. What are their alternatives? This is your ticket to the contract.