As previously published on In Business Wisconsin October 14, 2013 issue
By Mike Finn, senior vice president and market manager for commercial real estate for Associated Banc-Corp
Through midyear, the greater Madison area has continued to experience a surge in new real estate construction and rehabilitation. While a large segment of the activity falls within the multifamily sector, specialty projects are on the rise, keeping the market dynamic and vibrant. As the broader real estate market slowly reenergizes and new parties seek financing, it will be important to understand the loan evaluation process for various property types in today’s economy.
Underwriters not only assess the borrower but also inspect the property itself, and considerations can vary based on the type of property. The more traditional property types — retail, office, and industrial — all have fairly similar underwriting considerations. Existing income-producing properties are underwritten on the basis of their income stream and an analysis of various other factors, such as the duration of leases, whether the leases are gross or net, creditworthiness of the tenants, and overall occupancy rates (both current and trending). To-be-built properties will have similar considerations, but they require a review of preleasing commitments, general market demand, and velocity of preleasing, as well as some estimate of absorption of vacant space to a level of stabilized occupancy.
Underwriting specialty property types is where things become more complex. The more common specialty property types include student housing, hotels, golf courses, vacant land, and single-tenant retail stores. Each of these property types will have different underwriting criteria to consider. The following is a brief overview of those criteria, segmented by property type.
Lending for student housing will involve a review of general market conditions and feasibility studies, but it may include a more macro-level analysis of past and future enrollment trends to ensure acceptable occupancy levels. Some universities have been willing to provide master leases, which will provide the added benefit of their credit.
Hotels are unique in that the income stream is more reliant upon an operating business than a real estate loan. Typically, loan-to-value will be more conservative and debt coverage ratios will be high to account for occupancy trends and the seasonality of the hotel business. The experience of the hotel developer and management are viewed as very critical pieces to lending on hotels. Additionally, the franchise flag — such as Holiday Inn, Hilton, etc. — is also of significant importance.
Golf courses are definitely a unique, special-purpose property type and will usually be leveraged at a more conservative level to account for golfer demand, weather, and what is in most cases a relatively short season in the Midwest.
Vacant land or even fully improved land has been difficult to finance in recent years. Underwriting will usually involve a more conservative leverage model and will attempt to estimate the likelihood of development within the near term. The warehousing of vacant land has not been as prominent since the economic downturn, but with the return of the housing market and the lack of inventory of improved lots for new construction, subdivision lending on a select basis has seen an uptick.
Single-tenant retail stores
Location is of course important, but sales per square foot, annual sales trends, and the creditworthiness (credit-rated tenants) would also be important considerations during analysis. Additionally, a situation with a longer-term lease is preferred.
While the process and underwriting considerations will vary based on property type, it is important to remember that full-service banks are equipped to finance a wide variety of properties and meet the needs of many customers. So if you’re in the market for development, be sure to consult with your relationship manager to ensure that you understand the intricacies of the financing process for your next property.