Credit Rationing, Capital Constraints, and Real Estate Development Activity

The credit-rationing policy of lenders and the internal capital constraints of real estate developers tend to evolve in a cyclical pattern. In unfavorable states of nature, for example, developers tend to require a higher risk premium per unit of risk and therefore refrain from investment activity. At the same time, lenders tend to be more cautious. Thus, one might suspect that development activity would rationally come to a complete halt during these unfavorable states. This chapter, linking the issue of credit rationing to the optimal timing for commencement of real estate development, presents a model according to which developers, forming various expectations with respect to lenders' credit policy and their own capital constraints, may tend to rationally increase their demand for forward construction-loan commitments, which, in turn, will lead to higher than otherwise investment activity during unfavorable states of nature. The above is a corollary to the conclusion that the cyclical behavior of lenders' policy and capital constraints may increase the values of undeveloped land due to a certain additional option possessed by the developer. This is particularly true when the developer's horizon is finite due to significant carrying costs or expected change in the zoning law or when the developer owns an option on the land that is about to expire. The model assumes that credit rationing is a policy measured on a continuous scale and that the creditworthiness of a developer is entirely characterized by the properties of the project