The Most Dangerous Number on a Term Sheet
Choosing a Lending Partner for the Troy Project
In my previous post, I talked about how I read a term sheet. The thing is, reading a term sheet and choosing a lender are not the same thing. Reading tells you what the lender is offering. Choosing tells you what kind of relationship you want with your lender for the next several years.
On the Troy project, we were fortunate enough to have multiple institutions interested in financing our deal. Two of the strongest contenders were Pioneer Bancorp and Broadview FCU. These two banks took the time to look behind the numbers to understand how our business works. Sometimes the numbers tell a misleading story on the surface. Partners that take the time to look under the hood to understand those numbers are in store for a good deal. Those that don’t pass on the deal because it is not “vanilla” enough.
At first glance, the term sheets looked remarkably similar. Both were construction-to-permanent loans. Both required personal guarantees. Both used a thirty-year amortization schedule once stabilized. Both required environmental reviews, appraisals, title insurance, and construction monitoring. Both institutions clearly wanted to lend money on the project, which is precisely why comparing term sheets can be so difficult.
Most investors would immediately jump to the rates and loan amounts. That’s a mistake. The most important differences are often buried three pages deep inside the document.
Let’s start with the obvious stuff. Broadview offered a higher total commitment of up to $2.19 million compared to Pioneer’s $2.0 million. Sounds better, right? Not so fast. Broadview’s structure was split between an initial construction tranche of $1.98 million and a future earn-out tranche of up to $210,000 available only after stabilization and subject to a long list of conditions.
Pioneer, by contrast, kept things simple. Up to $2.0 million, subject to loan-to-value, loan-to-cost, and debt-service coverage limits. No separate earn-out structure. No second approval process after stabilization. That said, Pioneer did discuss a B-note (an add-on mortgage) to cash-out after stabilization, but since we already had a commercial lease during the underwriting process the bank decided to push the difference into the first loan and increase the initial funding. This may sound like a minor difference, but psychologically it is enormous.
The bank only lends the last dollars for the project, so borrowing the cash upfront avoids the need to cough up a couple of hundred thousand dollars, only to get it back at the end of the project. As a developer, I don’t want to plan my project around money I may or may not receive later. If I need $2.15 million to make the project work, then I need $2.15 million today. Future conditional money is nice, but it is not the same thing as committed capital.
Then there was the equity requirement. Broadview required the borrower to contribute roughly 37% of total project costs and specifically referenced an additional equity injection of approximately $410,000 while Pioneer only required an 80% loan-to-cost ratio. In practical terms, Broadview wanted significantly more cash in the deal from me before they became comfortable releasing their borrowed funds.
This difference tells you a lot about how banks think; neither was saying the deal was bad. They were answering a different question: “How much of your own skin are you willing to put in the game?” When a bank demands additional equity, what they are really saying is that they would like you to absorb more of the early risk.
Next came the construction timeline. Broadview structured the loan around an eighteen-month construction period. Pioneer allowed two years of construction and stabilization before conversion. That’s an additional 6 months of interest only payments to help get the property stabilized, should we need it.
Now let’s take a step back and think about the Troy project. This project isn’t a suburban townhouse development where the developer has already completed twenty identical projects down the road. This is the adaptive reuse of a historic downtown building. We are changing layouts, converting uses, adding additional square footage, dealing with old construction, navigating municipal approvals, historic restrictions, and coordinating numerous professional consultants.
In a project like this, time is risk. The more experienced I become, the less I trust construction schedules. An extra six months may not sound important. In reality, it can be the difference between calmly solving problems and desperately scrambling to hit a lender-imposed deadline.
Then we get to the section that surprised me most. The prepayment penalties. Broadview had none. Zero. The loan could be paid off at any time without penalty. Pioneer had a declining 5%, 4%, 3%, 2%, 1% structure that reset again after the rate adjustment period if the loan was refinanced. If I am able to pay cash to pay off the mortgage there is no prepayment penalty. This was easily Broadview’s strongest feature. But a penalty some time in the future that may or may not exist depending on a refinance is not something I assign a lot of real risk to. On the other hand, flexibility wasn’t free. Broadview’s commitment fee was 100 basis points, or $21,900. Pioneer charged 50 basis points. Again, neither lender is right or wrong. One lender charged for flexibility up front. The other charged for it later.
As homeowners, we are trained to look for the lowest interest rate. As investors, flexibility is often more valuable. Real estate markets change. Interest rates change. Banking markets change. A loan with no prepayment penalty gives the borrower optionality. If a better opportunity appears, you can move. If rates drop, you can refinance. If another lender becomes more attractive, you can leave. That freedom has value.
Then we arrive at the section of the term sheet that ultimately mattered most to me: construction administration. This is where the two institutions revealed how they thought about risk. Broadview required lender-approved consultants, monthly construction draws, extensive documentation requirements, interest reserves, municipal approvals, surveys, contractor lien waivers, assignment of contracts, and numerous other controls around construction funding. Pioneer required construction monitoring as well, but the overall structure was substantially simpler and more flexible.
Many readers will assume simplicity equals less protection. For the bank, that’s true. For the borrower, however, simplicity has a different benefit: speed. Construction projects run on momentum. Contractors show up when they’re supposed to. Materials arrive when they are needed. Decisions happen quickly.
Whenever the financing structure slows those decisions down, costs start creeping upward. The irony of construction loans is that the lender’s risk management can create additional project risk. Not intentionally, but mechanically. That realization shaped my final decision. None of those factors carried as much weight as flexibility during execution. This project already had enough uncertainty built into it; historic restoration always does. The last thing I wanted was more friction between construction and the capital required to keep moving.
In the end, I chose Pioneer because the structure fit the project better. The additional construction timeline, simpler administration, and greater operational flexibility outweighed the advantages Broadview offered elsewhere. What makes this lesson interesting is that another developer could easily have reached the opposite conclusion.
If your strategy relies heavily on refinancing, Broadview’s lack of prepayment penalties might be incredibly valuable. If your project is simpler, faster, or less construction-intensive, the additional controls may not matter nearly as much. That is the real lesson to take away from comparing these two term sheets. There is no absolutely “best” term sheet.
Most investors shop for loans the same way they shop for gasoline. They look for the cheapest price and assume everything else is basically identical. The longer you spend in real estate, the more you realize that financing is not a commodity. Financing is a partnership. The lender is giving you money, while inserting themselves into your project, timeline, reporting process, and ultimately, your decision-making.
That is why I always start with the same question: Who wrote the term sheet? Because once you understand the lender, the rest of the document starts making a lot more sense.
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