“Fortunately, most of our projects are capitalized and financed, but there is an extraordinary crunch in the availability of construction loans and senior debt, which is having a big impact on development as well as acquisitions,” explains Carter. “The lenders are very picky, and the demands on the borrowers are probably as great as I've seen in my career.”

What are those demands exactly? “Lenders are looking for substantial guarantees, they're looking for substantial leasing, they're looking for virtually no construction risk, and the spreads on their pricing are greater than historically.”

Construction financing is linked to the benchmark three-month London Interbank Offered Rate (LIBOR), which was pegged at 1.14% as of Jan. 16. In a normal, or less volatile market, the spread over the three-month LIBOR is typically 100 to 200 basis points for construction financing, says Carter. Today, that spread ranges from 300 to 700 basis points.

Carter is developing the Streets of Buckhead, a luxury mixed-use community in the heart of Atlanta's Buckhead neighborhood, once famous for its nightlife. The first phase, which is 50% leased, will open in March 2010 at a cost of $600 million and include 400,000 sq. ft. of retail, about 80 retailers and 14 restaurants. CB Richard Ellis Strategic Partners is providing the construction financing.

The Buckhead project's second phase may include more retail, restaurants and a residential component. “We're going to watch the economy as to when we start Phase II.” Carter hopes to start it in 2010.

The cost of financing can make or break a project, and never has that been more true than today. Associated Estates Realty Corp., an apartment REIT whose portfolio includes more than 13,000 units principally in the Midwest, just scrapped plans for a joint-venture project due to problems tied to construction financing.

Associated Estates planned to take out the apartment developer at a pre-determined price after completing the project. But the developer could not obtain construction financing at favorable terms.

“The developer expected to get 65% to 70% loan-to-cost. The loan was probably going to be in the vicinity of 50% loan-to-cost,” says Jeffrey Friedman, president and CEO of Associated Estates, based in Richmond Heights, Ohio. “This was a development team with more than a 10-year track record of developing, designing, owning, managing and leasing up apartments in a number of markets.”

The onerous terms meant that as a joint venture partner Associated Estates couldn't achieve an internal rate of return of 12% to 15%, its target for new development, so the proposed deal was shelved.

Dramatically altered landscape

For borrowers who have never endured a major retrenchment in the capital markets, this downturn shows how suddenly dramatic market swings can occur.

“Borrowers have been humbled. That's the reality,” says James Merkel, president of Columbus, Ohio-based RockBridge Capital LLC, which has provided $1.4 billion in debt financing to the hotel industry since 2005. “Borrowers do not have the negotiating power they had. Today, it's more about access to capital and liquidity than about the ability to negotiate the best deal.”

Respondents say recourse loans make up 51% of their current debt vs. 49% for non-recourse loans [Figure 7]. While the majority expect that ratio of nearly 50-50 to remain the same over the next 12 months, nearly one in four (23%) expects the percentage of recourse loans to increase. Only 12% expect it to decrease.

One-third of the commercial real estate loans originated in the past 10 years were structured as commercial mortgage-backed securities (CMBS), loans packaged and sold as bonds to investors, estimates David Rifkind, principal and managing director of Los Angeles-based George Smith Partners. The company has arranged in excess of $10 billion in commercial real estate financing since 2005.