Conservative lending will help industry avoid over-building in a tight market.

Healthy market conditions in the tri-state area have created a prime climate for stepped-up real estate development activity. However, the lenders that lent so liberally in the heyday of the 1980's are keeping tight reins on construction money, which will help to avoid the over-building that contributed to the real estate crash earlier this decade.

Today, funding for speculative development is virtually non-existent. During the past few years, REITs and some institutions launched the first speculative projects since the decline, encouraged by healthy capital markets and an improving economy. Since the bond market disruption last fall, REITs have been struggling to raise equity, and Wall Street firms offering 100 percent financing have shut down. Now, construction lenders are requiring private developers to self-finance as much as 50 percent or more of speculative construction.

Speculative projects that are under construction involve developers with deep pockets, and those who have formed strategic partnerships with institutions that can contribute ready capital.

One example of an owner partnering with an institution occurred at Reservoir Corporate Centre in Shelton, CT. Situated on 20 acres, the project will ultimately include 400,000 square feet in three buildings. It is owned by The Davis Companies, a 20-year-old real estate investment, management and development firm which has purchased, renovated and developed in excess of $320 million of real estate in Connecticut, Massachusetts, New Hampshire, Pennsylvania, New York and Texas. The Davis Companies teamed up with Prudential to provide financing for one of Fairfield County's only speculative office developments. Cushman & Wakefield is serving as leasing agent for the project.

Another Connecticut facility was built by Powers Construction Company of Danbury, CT. It is a 135,000 square-foot expansion at 40 Apple Ridge Road in Danbury. The new 230,000 square-foot property serves as a divisional headquarters for HFS Mobility Services. The tenant's long-term commitment to the property enabled Cushman & Wakefield to arrange a $48 million long-term construction loan for this facility.

Equity and Debt Funding For New Construction

The good news is that owners/developers have the ability to secure equity and debt packages for new construction that is at least partially pre-leased. In some cases, select institutional sources will provide up to 90 percent of the required equity for new construction of apartments, retail, office and industrial. Normally, the equity requirement is for 25 percent of the total cost of the project. Therefore, a developer, in some cases, need only to put up 10 percent of that amount (2.5 percent of the total cost of the project).

Although this is not a new option, many of these funding sources dried up during the interruption of the markets last year, and are now available on a limited basis.

The Future of Funding

For the next couple of years, financing will remain available for well-conceived new development projects and existing properties. In addition, interest rates are expected to be lower by year-end. These trends are likely to continue through 1999 and into the early 2000s. And while the careful approach that defines lending today poses increasing challenges to developers, it will keep the market healthier in the long run.