Commercial Real Estate Finance

The New York State Supreme Court Appellate Division ruled last Friday that Citigroup must maintain the “status quo” of the Destiny USA New York shopping mall project.  Basically, that means that Citigroup will not yet be allowed to cease lending to the construction of the mall being built by developer Robert Congel.  While it is still possible for Citi to get out of the remainder of the loan commitment (the lower court still has to have a trial on the “success” of the project), the ruling sets a precedent that will make it increasingly more difficult for lenders to renege on their construction financing commitments.

Congel is developing a huge retail project that has no tenants.  It’s obvious that there isn’t a bank in the world that would loan to a speculative project like that today.  The fact that Citi has to uphold their financing commitment is inconsequential to most banks because they are not going to originate loans like that anyway.  But what does the ruling mean for non-speculative construction loans in less risky property types?  The bottom line is that if a project runs into trouble, which it very well may in this environment, it will not be as easy to just stop lending.  Even if a deal has significant risk mitigation (pre-leased, strong demand generators, exit strategy, etc.) this ruling suggests that banks should have less control in failing construction deals.  Why then, would a bank do a construction deal even if the fundamentals were strong?

Destiny USA Mall

This ruling definitely puts further strain on the market for construction financing.  Lenders are willing to take a bit of risk if the yield is right and it is clear that they have the option to back out of their commitment if the developer does not live up to his end of the deal.  But I can’t think of a single lender who would walk into a risky financing—no matter how high the yield is—if they cannot be certain on whether or not they have the right to back out when the developer fails to perform.  NY State Supreme Court’s decision in this case does nothing to provide that certainty.  Until lenders and their counsel can figure out a way to build that certainty back into their lending agreements, we can say goodbye to ground-up construction financing.

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