The new home market continues to show steady, albeit, slow improvement. General sentiment at the recent International Builders Show in Las Vegas could be categorized as cautiously optimistic for 2015. The primary drivers of new home sales, including healthy job formation, low interest rates, improved household formation and easing mortgage underwriting requirements should give new home sales a boost.
The NAHB is forecasting new single-family home sales to increase 29 percent to 564,000 from 2014 to 2015. This healthy increase will require substantial capital to bring SFR lots and new homes to market. Will there be adequate capital availability to fund this increase in new home development?
According to an FDIC and NAHB analysis, the outstanding stock of 1-4 unit residential AD&C loans made by FDIC-insured institutions rose 3.66 percent to $1.765 billion during the third quarter of 2014. The third quarter expansion marked the sixth consecutive quarter of increase. Despite this positive trend, the current outstanding AD&C balance of ~$50 billion is approximately 75 percent off the peak outstanding of $203.8 billion seen in the first quarter of 2008.
An increasing number of banks have re-entered the market as it becomes apparent that the current housing recovery has legs. The availability of credit is driven largely by the strength of a homebuilder’s balance sheet. The public and large private homebuilders with strong balance sheets are, in large part, obtaining the financing they need. Smaller homebuilders and homebuilders who have not re-built their balance sheets are finding it more of a challenge to get bank financing.
This was evident from the questions and feedback received in my discussions with homebuilders and capital providers at the IBS event. The availability of financing is also highly dependent on the stage of collateral. Financing for vertical construction is readily available; however, financing for A&D loans is more difficult to find while financing for land loans is rare.
Banks continue to be under heavy regulatory scrutiny. They are also adjusting to new regulations such as Basel III and Dodd-Frank. This has caused them to be more conservative in their underwriting. It has also, in many cases, impacted turnaround time due to increased regulatory tasks that reduce available time to originate, underwrite and close loans.
Non-regulated lenders remain active in the space and are a viable alternative to commercial banks. Although their cost of capital is higher than a bank, they offer some advantages such as higher advance rates, non-recourse, and speed to market. There have been some recent land banking and mezzanine financing transactions done in the market; another indication access to capital is improving.
The availability of equity for homebuilders is also on the rise. The investors range from large opportunity funds to “country club members”. There are well-known, long-time investors as well as new entrants. Billions of dollars have been raised in various real estate funds for commercial real estate. We are now seeing spillover to the forsale residential space, as these funds need to put their money to work.
Co-invest requirements, preferred returns and water fall profit splits have started to improve for the homebuilder. That being said, many of the equity sources say they are having a difficult time finding attractive deals due to the increased cost of land and the inelasticity of home prices.
The homebuilding finance arena continues to evolve. The use of a financial intermediary, such as Landmark Capital Advisors, can help a homebuilder navigate the world of real estate capital. Most homebuilders cut back their staff significantly during the recent downturn, including their finance and accounting staffs. A financial intermediary can provide assistance in putting together a concise equity and/or debt package as well as introduce the homebuilders to debt and equity sources that are the best fit for his project. This frees the homebuilder up for what he does best, which is building and selling homes.
Tom Farrell is Director of Business Development for Landmark Capital Advisors, a Land Advisors company. Landmark sources debt and equity for homebuilders, land developers and commercial developers nationwide. He may be reached at firstname.lastname@example.org.