In response to Dodd-Frank, the controversial 2010 federal legislation intended to boost lender resilience to market downturns (and prevent another Great Recession like that of 2008), commercial real estate lenders are making it much more difficult for borrowers to secure bridge and construction financing without increasingly onerous terms.
The thicket of new edicts can have disadvantageous consequences for developers, including those in the hospitality industry, from obtaining a loan in the first place to the ultimate repayment and exit.
Control of Asset and of Cash
In the post Dodd-Frank context, it’s more important than ever for borrowers of construction loans to thoughtfully negotiate their loan documents. The following lists some of the issues that should be considered:
Seek as much time as possible in loan documents for “cure periods,” in case covenants are breached or payments become delinquent. Banks may give more time if pressed to do so at the term sheet stage of negotiations, rather than later in the process. At such early stage, the bank is eyeing new business and associated loan fees, and is more amenable to negotiating the fine points of a loan document. The time to ask for concessions is not when the definitive loan documents are being negotiated and certainly not at a subsequent point when a project may be ailing, and the relationship—and leverage—between borrower and lender has shifted.
Check the loan transfer provision in the context of your exit strategy. In a sale transaction, coupled with a loan assumption, it is extremely valuable to have the lender obligated to release all existing guarantors upon the buyer’s delivery of a satisfactory replacement guarantor(s). The last thing a developer wants is to retain a contingent liability under a guaranty for a project it no longer owns.
Confirm in loan documents the availability of funds at all times to operate the project, even in the context of a default. Even if the lender controls the cash under a cash management agreement, they should be obligated to fund necessary operating expenses—to “keep the lights on”—while the borrower works to cure the default.
Markets abhor a vacuum, and non-bank lenders have entered into construction finance markets (particularly for hotels) to provide financing alternatives for borrowers. The non-bank lenders are blissfully free of many regulations, and typically move more quickly.
But borrowers should be forewarned, the non-bank lenders are shrewd and opportunistic, and certainly not afraid to assume control of a property in case of defaults, or to aggressively assert rights when covenants are broken.
In summation, hotel industry borrowers need to competitively shop loan terms (and lenders) up front and negotiate important loan terms early in the process, aided by expert counsel. Asking for variances after a project goes sideways could be a very expensive proposition.
About the Author
Scott Kalt is one of the founding partners of Los Angeles-based law firm Elkins Kalt and co-chair of the firm’s Hospitality and Leisure Practice Group. Shai Halbe is a partner in the firm and member of the firm’s Hospitality and Leisure Practice Group.