Let’s talk about how we are planning on paying for this project of ours. Peter here! This is a good one to skip if you don’t want a probably too long post about our project finance. I will not be holding back!
As you hopefully picked up from our discussion about budgets, we didn’t really stick to our initial goal. In fact, we blew that original budget out of the water. Then, for a fun wrinkle, our economy plunged into a major crisis as COVID-19 spread across the globe, stocks plunged briefly before making a wild recovery (also stonks), and many of us sat at home wondering if and how anything would ever get back to a comparable “normal.” Now it’s time to pay for a major construction project! Cool cool cool. Financing this project has probably been my main contribution, other than the solar panel elements. I have been working with various lenders to see if we can make something work for probably 18 months now. Part of this is because we ended up delaying our project a year, as referenced in our post about budgets. Mainly, though, financing this project simply presented its own challenges and I wanted to give us a long runway to figure out how to make the money work. With unique projects like ours, I have learned that there is a sweet spot in which banks to talk to. Small, local banks likely don’t have the risk profile or tolerance to take on the project. They may not even have the financial mechanisms in place. Big banks have some standard products in construction finance that probably could work, but the terms weren’t great and there wasn’t much flexibility in term length, payment schedule, and underwriter needs, not to mention restrictions that they started implementing to hedge against a potential recession. Those last two pieces can be challenging because underwriters can get a little spooked by projects they don’t know enough about. What worked best for us was to work with a midsize, regional bank (we are working with Old National). This gave the bank a big enough portfolio and risk tolerance to work with us, while still being small enough to be somewhat personable and flexible to work with our needs. Our process started, quite honestly, with me making several cold calls. Sometimes I would get routed around to the various mortgage groups. As we have mentioned, our project is weird. We are refinancing a contract for deed that we have in place for our triplex to a traditional mortgage to open up our wider lending options (home equity financing or construction financing). We aren’t a traditional mortgage, though, because we are immediately trying to build a new structure on the property. Are we a quadplex? A triplex + a single family home? Two separate properties? Who knows! This confusion scared some banks off or ended up with me getting routed to people who couldn’t help me. Eventually, though, I found a few folks who weren’t the correct people but were interested/curious and helpful enough to get me to their higher ups. I was given the chance to pitch our project and convince them that they should give us a chance. We settled on a construction loan style that would refinance the property out of the contract for deed (so the deed will move to the bank like a traditional mortgage). At the same time, the bank would issue a 4x5 construction loan. We were allowed to lend up to 80% of the value of the appraised future property minus the outstanding amount owed on the existing mortgage. The amount of money that we want to borrow will be amortized as if it were a 30 year product, but there were then 4x 5-year terms where the loan would be updated and renewed. At the end of that final renewal term, there would be a balloon payment for the remainder of the amount. (If all of the above made your eyes/brain hurt, some more details are below.) The downside of this structure is that the interest rate gets updated at each renewal. With the economy being rather tense right now due to COVID-19, lending rates are incredibly good. I would love nothing more than to lock this into a traditional 30-year mortgage product and be done. With our major construction piece, though, we couldn’t do that. A traditional home equity refinance would have only covered ~40% of our build cost and we didn’t have the cash to cover the remainder. So, hopefully interest rates don’t skyrocket at any of the 5 year renewal points. The interest rates are at least locked in during the 5-year terms. The upside of this financing scheme is that we will have the option of refinancing to a more traditional product at any of the 5-year renewal time periods. If interest rates stay low, for example, we could convince a bank at that point to convert all of the outstanding debt on the property into a traditional product and stretch the payments out over a traditional 15 or 30 year term. Now, I know many people wouldn’t necessarily be on board with paying all of the extra interest incurred by continually stretching out payments, but the saving grace of this project for us is that the triplex at the front of the property covers a large portion of the overall payment. It doesn’t cover everything in this case, but it certainly covers a healthy chunk. If we can stretch out the payments into the future to lower our monthly payments, we can cover more and more of that amount with our revenue from the triplex and maybe even get back to cash neutral or positive at some point. This last piece is a huge element for us. Though the triplex can make our property confusing for many banks, it also provides a big, revenue generating asset that banks liked as a collateral component. Being able to show rental history and project revenue made the banks more comfortable and at least willing to hear us out. I know other folks will have different collateral that they can use (stock portfolios, other properties, etc.), but this is how we did it. Turning our property into a quadplex, though, did add one extra challenge. To determine our lending limit, we had to get an appraisal of our post-construction property (our as-built appraisal). Minneapolis does not have many quadplexes (we actually had to get a special permit for this construction - see previous blog posts on Cluster Developments), particularly ones with one of the units being high end, eco-friendly, and brand new. Luckily, the bank we ended up working with found an appraiser familiar with environmentally-conscious construction elements (mainly solar, but better than nothing!). To close our financing, we have had to show tax returns, credit statements, title reports, full site surveys, construction design sets, zoning and building permits, building guarantees, and the aforementioned appraisal. We have provided an initial construction budget but are now waiting for our final construction budget now that we have our final design elements picked out and approved permits in place. Thanks for sticking with me through this long post! If you have questions, ask them in the comments below and I will do my best to answer.
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AuthorKatie Jones and Peter Schmitt chronicle their building adventure. Archives
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