News

The Current Financial Model for A&D Finance Costs Needs Recalibrating.

Accessing residential A&D financing continues to face headwinds. These winds have strengthened with the implementation of Basel III, more specifically HVCRE (“high volatility commercial real estate”). Development loans are now assigned a 150% risk rating for risk-based capital purposes versus the 100% formerly assigned. This makes it more expensive for regulated lenders to hold development loans on their books. Due to this, banks, in general, are reducing their development loan “mix” to reduce their costs. This is a logical course of action as development loans are inherently more risky than a term loan and hence should be treated accordingly. Banks will likely limit their exposure to development loans as well as ask for a premium in their A&D loan pricing as a reaction to these regulations. There are private lenders that are filling the void, one being the recently announced JV between Toll Brothers and Gibraltar.

These private lenders are materially more expensive than a traditional bank. Whereas a traditional bank today would charge in the mid-single digit “all-in” costs (coupon plus fees), a private lender will charge in the low to mid double digits “all in”. A developer should plan to pay in the range of 600-900 basis points higher than a bank when budgeting his costs. He should use this in determining what he can ultimately pay for the land. At the end of the day, land sellers need to understand this increased cost of financing and adjust their selling price accordingly. Granted, some landowners can decide to hold on and wait for a better day to sell; however, it does not appear that less expensive bank financing will return anytime soon in a meaningful way to the space.

Hopefully, the market will adjust over time leading to better access to A&D financing and addressing the critical shortage of lots in many markets that is hampering the ability to meet housing demand and driving down affordability.

 

Tom Farrell

Director of Business Development