By Craig Carbrey

No matter how alluring the project, no lender would take on a development without assurance that the principal of the loan will eventually be repaid. While a myriad of components play into the lending process, LTV is key.

Loan to value (LTV) is the ratio of the loan amount to the value of the collateral securing the loan. Traditionally, a conservative LTV would provide a margin that virtually ensured the repayment of the loan. Even if the borrower was unable to finish the project, lenders could rest assured that the property would be purchased at the foreclosure sale, many times at a greater pay-off than the loan. Those days are long gone.

The precipitous drop in value that continues to sweep across virtually all markets is now giving both lenders and appraisers fits in finding the “V” in LTV. As a result, very few loans are being made and the majority of closings are now driven by external forces that give owners no other option but to sell immediately. Meanwhile, the buyers in today’s market are opportunistic, seeking out long-term plays on distressed properties.

How dramatic has the drop in sales been? The Mortgage Bankers Association reported a 69 percent reduction in property sales for commercial/apartment transactions in 2008 vs. 2007 and 80 percent for the fourth quarter alone.

Concurrently, CB Richard Ellis reported on April 9, 2009 that cap rates have increased by an average of 150 basis points in 33 of 35 major metropolitan markets over the past year, with some markets increasing well beyond that. While cap rates have skyrocketed, construction costs remain high. Therefore the land residual value (improved property value less cost of construction) has diminished.

The end result: an 80 percent LTV loan made a year ago may now be at 100 percent, or worse. Say goodbye to the “V.”

This paradigm shift has literally changed the way lending is done. The old development scenario of “Build it (or in our business, ‘clean it’) and they will come” does not work in today’s economy. As a result, loans must be much more strategic and focused on obtaining the highest value on the exit.

Several brownfield redevelopment scenarios fit nicely into this new approach.

The rehabilitation of old legacy factories to affordable housing leading to a construction loan by FHA or other government sponsored program has seen increased activity and is filling a necessary void in the marketplace. Additionally, existing properties that are already in the remediation process are a great candidate for financing. These properties typically have an income stream sufficient to pay interest current. Of course, the gold standard is a project with a bona fide purchaser ready to take the remediated property into the next phase of development with no delays in the exit.

The profits from a strict land play can be significantly impacted by just a one year delay in the holding period as the interest carry and overhead reduce the profit. And with so much uncertainty in the market, waiting for an uptick is extremely risky. While no one can pinpoint just when the market will recover, there is widespread belief that a recovery will eventually occur. In the mean time, finding the elusive “V” and pinpointing prospects with the best opportunity for repayment on the principal is imperative.