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What developers do

O’Leary used an example to show why real estate developers are interested in maximizing their property valuations.

“If you're a developer and you've got a building on the block, anywhere in America, and it's worth, let's say, $500 million, and you want to build a building right beside it, you go to the bank and say, ‘This building is worth $500 million. I'd like to borrow a construction finance loan against this asset, and I want you to tell me it's worth $500 million, too,’” he said.

However, the bank might not agree with the valuation — it might value the property at $400 million. This would lead to negotiations. According to O’Leary, developers aim to present their assets “in the brightest light” possible to maximize their valuation since loans are typically 40% to 50% of the asset’s value.

In this example, the developer might secure a $250 million loan against a $500-million asset to finance new construction.

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Common practice

O’Leary notes that this practice is very common in the real estate industry.

“Forget about Trump, every single real estate developer everywhere on earth does this. They always talk about their asset being worth a lot and the bank says no. That's just the way it is,” he stated.

He then points out that this practice does not result in financial harm to any party involved.

“Who lost money? Nobody. The bank got paid back the construction finance loan, and a new building was built,” he said.

The ubiquity of the practice highlighted by O’Leary suggests that this is a broader industry issue rather than an isolated incident.

“If you're going to sue this case and win, you've got to sue every real estate developer everywhere,” O’Leary remarked.

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About the Author

Jing Pan

Jing Pan

Investment Reporter

Jing is an investment reporter for MoneyWise. He is an avid advocate of investing for passive income. Despite the ups and downs he’s been through with the markets, Jing believes that you can generate a steadily increasing income stream by investing in high quality companies.

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