By: Brandon Wilhite
With the resurgence in interest in living in denser, urban walkable environments, development patterns across the country are shifting from single-use developments, such as a retail power center or an office park, to mixed-use developments consisting of retail, residential, office and restaurants. This trend is fueled by both younger and older generations alike. Young Millennials have no desire to spend significant portions of their days in their car and want to live in close proximity to both their place of work and their favorite neighborhood hotspots. Likewise, empty nesters are finding themselves no longer wanting to maintain their 3 or 4 bedroom houses now that their adult children have moved out and want to downsize, ridding themselves of the burden of maintaining a pool or yard.
A large part of the appeal of urban living is the proximity to the lifestyle and leisure, such as restaurants, coffee shops, bookstores or gyms. Urban dwellers are particularly drawn to new, unique and innovative businesses that are often independently owned. A restaurant owned and operated by a local chef is generally more likely to be patronized than a generic national chain restaurant. But, therein lies the problem…
Lenders and investors often focus on the credit of tenants when underwriting commercial real estate. The stronger the credit of the tenant(s), the lesser the likelihood that they will default on their lease payments, thereby reducing the risk to both investors and lenders. However, focusing on credit in an urban mixed-use development can create an interesting paradox. The local restaurant owner may not necessarily have bad credit, but his balance sheet is often not sufficient for a lender who is underwriting a loan whose debt service will be paid by that tenant’s rental income. This is less of a problem in a refinance or acquisition when a lender can look to the historical performance of a property and its tenants. However, when underwriting a new development, a lender won’t have that luxury.
Our team at Metropolitan Capital (“MCA”) has quite a lot of experience in working through this issue for our clients. Here are a few strategies we have found to be helpful in getting lenders comfortable with these types of tenants:
- Sell your tenant’s background and resume. If your tenants have a proven track record of success, this can go a long way. Is their business a proven concept or a new one? How many other businesses have they started, and how have they performed?
- Sell your tenant’s concept and why it will be well-received in the development’s location. If kebabs are the hot new trend and your tenant has a quick-serve kebab concept to serve the neighborhood workforce population who have previously had to drive 5 or 10 minutes to get their kebab fix, then that is a compelling recipe for success and should be emphasized!
- Sell the depth of the market. Tenants’ going out of business is unfortunately a fact of life. However, urban developments or redevelopments can typically be found in supply-constrained markets, which can often mean that space can be very quickly leased to any of a number of tenants who have been waiting for an opportunity to find space in that market. A highly coveted market is a huge risk deterrent.
If all else fails, it may be time to consider some financing options in order to get your deal done, which may be less attractive initially but will still allow you to execute your business plan. One option may be to de-lever down in the 50% to 60% Loan-to-Cost range in order to get the lender comfortable with the risk. At lower leverage, a tenant default is less likely to negatively affect the borrower’s ability to service their debt.
Another option may be a private (non FDIC-insured) lender. A private lender can often get you to your desired loan proceeds, albeit at a higher interest rate. Depending on the borrower’s confidence in their tenants, this may option may enhance risk, as a tenant default is more likely to negatively affect the borrower’s ability to service the debt at a higher interest rate.
While the above options may be less attractive initially, they are often an effective temporary strategy to get your development financed and to get your tenants in occupancy. Once the development has been built and your tenants have established successful track records, you will have an easier path to obtaining traditional bank financing.
Obtaining financing for what many banks consider to be “non-traditional” developments can often be tricky. MCA’s experience can prove to be invaluable in assisting borrowers to navigate through this process. For further information on how Metropolitan Advisors can help you finance your next mixed-use development, please contact Brandon Wilhite at firstname.lastname@example.org or visit our website at www.metcapital.com.