What will construction financing look like in the post-COVID-19 economy?

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Whether we are headed for a tough start to 2021 with a COVID-19 cloud still looming or a post-COVID-19 economy in full recovery, capital for construction and development projects will be in strong demand.

Developers will see opportunities with real estate rotations and investors likely will remain thirsty for returns as other investment vehicles stabilize. New demand drivers have emerged in almost all sectors of real estate created by business closures, new competition and new opportunities created by the pandemic.

I recently spoke with two individuals who spend much of their time contributing to the capital stack of new construction and development projects. The combined perspective of a commercial banking executive and a real estate investment professional helps paint the picture for anyone contemplating development in 2021.

Debt and traditional financing

Generally, the banks continue to be supportive of construction projects, but underwriting is more conservative going into the winter and spring seasons. This is not surprising with the continued uncertainty around the pandemic and the looming questions about Paycheck Protection Program loan forgiveness and economic stimulus.

Cash flow is king in underwriting right now, and banks may look more closely at the financials of prospective tenants, as well as consider the industry of those tenants. The banking executive that I spoke to noted specifically that owner-occupied manufacturing projects currently are viewed as favorable.

The interest rate environment should remain attractive for the foreseeable future, but banks will look more favorably toward “disciplined” sponsors with projects that hit “the middle of the fairway.”  Sponsors need to carefully consider the markets and industries that will drive cash flows because the banks are watching closely.

Equity investment

The investor perspective generally aligns with banking, but with a few small differences. Investors will favor deals in markets where the future is more certain. In the near term, retail, office and hospitality projects will certainly get more scrutiny if not a hard and fast “no.”

The investor that I spoke to said the “antennas are up for risk,” which is a natural reaction to economic uncertainty. Sponsors looking for funding right now need to consider that relationships do matter to investors.

For instance, when approaching savvier investor groups, make sure you bring solid banking relationships to the table. Operational and organizational expertise also will help strengthen your story as a project sponsor.

All these attributes combined serve to de-risk your deal to investors. The importance of relationships is one of the biggest challenges right now; how do you form a new relationship through a Zoom call? Sponsors who figure this out or lean on past relationships will still find success in this market.

So much of the answer to financing questions is situational. There are groups in the market that are hunting for the opportunities created by the pandemic, and they are willing to bet big. Others have pulled back considerably and are choosing the wait-and-see approach.

There will be winners in all types of development, but the projects that follow time-tested, conservative investment principles will have the best chance in the post-pandemic recovery.

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