July 02, 2005

Commercial Financing and Entitlement Risk

Entitlement Risk is the Risk That the Government Will Never Let You Build

Commercial mortgage brokers and commercial property developers frequently come on to C-Loans.com and apply for a land development loan to pay for an environment impact report or a traffic study or to draw up preliminary plans or to finance the cost to apply to the city or county for a zoning change or a change to the master plan.

In other words, the developer does not yet have preliminary approval to build. In many cases, the government will never allow the proposed project to be built. Perhaps the project will create too large of a traffic snarl. Perhaps the neighbors will demonstrate at the planning commission meeting saying, "Not in my backyard!". Perhaps the triple breasted golden butterfly makes its only breeding ground on your land. A million obstacles could arise to prevent the developer from receiving preliminary government approval.

As a result, institutional and even hard money lenders will rarely take on "entitlement risk", the risk that the government will never allow you to build.

In order to get the funds required to obtain preliminary government approval, the developer will either have to use his savings, borrow against other assets (rental houses, his office building, etc.), or go to private investors to raise equity dollars. An investor who contributes equity dollars becomes a part owner, and the equity holders are the first ones to suffer a loss if the project heads south. Hence equity dollars can often cost 35% or more annually.

You can find hundreds of commercial construction lenders on C-Loans.