A More Conservative Stance

We are living through a moment in history where circumstances seem to be changing almost daily. With that less certainty, there’s less that you can count on.

When you’re negotiating a transaction between two parties, there are three sources of uncertainty. There’s the uncertainty that I bring to the transaction for items that are within my control. There’s the uncertainty that the other party brings to the transaction through items that are in their control, and then there are factors contributed by third parties to the transaction where it’s outside the control of both parties.

We’ve seen first hand, and second hand cases where investors have decided to pull back from commitments and sit on cash, choosing to do nothing for the time being. If you’re raising money in today’s environment, you have to assume that you’re going to get some investor attrition. It might not be large numbers, but you might plan on losing 25% of your investors just because of the uncertainty in the current market conditions.

In my conversations with other developers, I’m aware of cases where the drop in stock market values has directly made less capital available for investors to deploy into real estate transactions. This is real and I have to tell you that raising capital just got harder in the past few weeks.

For the moment, this hasn’t impacted the lending environment. But that too could change. Lenders come in all shapes and sizes. If you’re relying upon financing for a project, you may want to consider taking a more conservative approach in your negotiations.

In at least one case, we’ve added a financing condition to a transaction, even though we have no indication that there are any changes to the financing commitment.

We’re living in a highly interconnected world where counter party risk exists all over the place. You might have a private bridge lender who is fully on board with your project. You might have a term sheet, a good appraisal, and green lights everywhere. Then at the closing table the lender might not come through.

This happened to us with a reputable bank back in December. In that case, it was a situation where the bank was missing the paperwork for a partner bank that was co-funding the deal. It took a couple of weeks to resolve and everything was good. But we had no visibility of the fact that a second lending institution was involved in the loan. This is an example of the types of complexities that exist in the financial system. This stumble was nothing more than a benign administrative error.

Fast forward to today where we have a highly fluid situation that is changing from one day to the next.

I believe that you should not be signing any purchase agreements without a financing condition. You might have a lender failing to perform at the closing table at which point you need additional time to secure alternate financing without putting investors monies at risk in the form of non-refundable deposits.

I also believe that you should be much more conservative and unless you have the cash in hand to close, your earnest money deposit should be in trust with a lawyer, a title company a real estate brokerage, or other appropriate trustee for those funds.