Originally published on March 22, 2023, by Yonah Sturmwind and Kathy Kozak for NAIOP E-Newsletter.
“Where there’s a will, there’s a way.” This adage has never been more relevant for developers looking to finance new building projects. With Federal Reserve Chair Jerome Powell indicating that the Fed will continue to raise interest rates, traditional capital providers with strained balance sheets are pulling back on lending. And given the current economic outlook, many senior warehouse line lenders may also look to pull back on financing, opening the door for a more direct asset-by-asset approach. As a result, borrowers need to seek out alternative lenders that creatively finance their projects – enter nontraditional lenders and loan-on-loan financing partners.
How loan-on-loan financing works
Loan-on-loan (also known as “note-on-note”) financing is a common form of capital stack formation for bridge and construction lenders and offers a perfect example of a nontraditional lending approach that can provide financing for borrowers in a challenging environment. In a loan-on-loan arrangement, a senior lender (such as a bank, life insurance company or specialty lender) makes a loan to a building developer. That lender then secures senior financing for that loan from another capital provider at a lower rate, thereby increasing their margin and allowing them to offer more competitive terms to the developer. The loan-on-loan is collateralized by the loan to the developer and occupies the last loss position in the capital stack.