Landmark Links January 20th – Standoff


Lead Story…. There is no task in real estate finance today more difficult than securing a horizontal development loan.  Home builder acquisition, development and construction loans have become quite a bit easier to find over the past couple of years, assuming that a builder has decent financials and is willing to sign a guarantee (non-recourse is a bit of a different story).  However, obtaining horizontal development financing without a home builder exit is different.  Banks classify land development loans as more risky and, as such, they are much harder to finance.  In fact there are few lenders currently in the market (at least in California) even willing to make land development loans.  The very few lenders that are in the market are basically drinking out of a fire hose of quality deal flow and are able to cherry pick loans that they want to make since there is basically no competition. This very limited number of lenders is also able to dictate extremely conservative loan terms and developers have little choice but to take them.  IMHO this is having a profoundly negative impact on the home building market today.

First let me explain how we got to this point.  Back in 2013, things were rocking in the residential development world.  Land was selling quickly and prices were going up.  Builders needed lot inventory and were willing to pay up for entitled but unimproved (paper) lots.  As such, buying or optioning large parcels of land, entitling it and then selling upon receiving entitlement approvals became a popular business plan with developers in markets like the Inland Empire.  The assumption was that someone with a lower cost of capital (typically a public builder) would complete the horizontal development portion of the project for a lower return, meaning that residual values were higher.  In addition, returns looked great on paper since developers weren’t budgeting for expensive horizontal work and California’s difficult entitlement environment means that there is typically substantial value creation once a Tentative Tract Map is approved.  Infill developers have been doing this for years and it still works well for them today.  However, infill sites are typically smaller and the liquidity profile for entitled land is much better in infill markets, both of which make builders likely to be more aggressive when buying.

The problems started when the market slowed substantially in 2014.  Builders weren’t nearly as aggressive when it came to acquiring lot inventory and retrenched to buying only blue-topped and finished lots in many markets.  In addition, mortgage financing remained tight and construction costs kept soaring as the labor shortage became more acute.  Virtually overnight, an entire business plan – that of entitling and selling lots to builders without moving any actual dirt became virtually obsolete.  Values have suffered and the volume of lot sales in many traditional production markets has dropped substantially.  Many developers (and capital partners for that matter) had assumed that the window to sell paper lots to builders would be wide, an assumption that turned out to be incorrect.  So now, the question is what to do next.  The paper lot market doesn’t appear to be coming back any time soon so developers and their investors are left with a choice: sell at a loss or break even, or finish the lots.

When the choice is to finish the lots, it can be accomplished by raising more equity or raising debt.  Equity is often out of the question since it requires a large check from already deal-weary partners and is dilutive to returns.  That leaves debt as the most viable option.  However, as stated earlier in this post, debt is tough to come by and the buzzword for lenders has become Pre-Sales.  In most cases, lenders require a very high number of the to-be-finished lots to be pre-sold to builders with deposits released before they will fund.  The strict pre-sale requirement presents a conundrum for developers.  There is often a lag of 8-months or more from the beginning of horizontal development to the sale of the first lot and builders are typically unwilling to release deposits that far in advance.  If the builder will release the deposit, he typically wants a substantial discount to the sale price.

The result of this stand-off between builder and developer at the behest of the lender is that many of the sites bought in 2013 or 2014 are sitting idle, even as home prices continue to climb.  Builders are not yet hungry enough to buy paper lots again, developers aren’t yet ready to sell at a perceived deep discount and banks are still way too conservative to scale back their pre-sale requirements.  I can tell you from first hand experience that this is a big issue, even when leverage is very low.  We are working on one loan in particular that was approved months ago but has been in funding purgatory awaiting the requisite number of pre-sales that the bank demanded while builders are shying away from committing capital months before those lots are ready to build on.

Eventually, something will break the log jam described above.  Either the builders will get hungry, the developers will be forced by their partners to sell at a discount or new funding sources will come in to shake the market up.  In fact, we know several equity investors who are close to launching debt platforms designed to address the severe lack of development capital available today.  Whether or not these new debt platforms are successful will depend on their loan structure and whether or not they can lend at a reasonable enough cost for equity partners to stomach, but that’s another topic for another day.


Justification: The US Consumer Price Index was up 2.1% year over year in December, the first time that Americans have experienced annual inflation of above 2% since 2014.  This will likely provide the Federal Reserve with a rationale for more rate hikes in 2017 if it continues.

Rising Tide: Rising oil prices are helping shale drillers get back to work….but costs are going up as well.

Giant Sucking Sound: Millions of Baby Boomers will hit the mandatory annual withdrawal age for tax sheltered retirement accounts this year, meaning that they have to begin taking distributions on their 401k’s….not necessarily by choice.


Resilient: Commercial real estate prices in the US are showing no signs of faltering, even in the face of falling interest rates.


Give and Take: Home builders are looking forward to a likely easing of regulatory restrictions, especially with regards to Federal environmental rules.  However, tighter immigration restrictions could be problematic.

Fuel on the Fire: Increasing mortgage rates are throwing fuel on the already raging affordability fire in high priced coastal markets.


Addition by Subtraction: The City of San Diego didn’t allow themselves to get fleeced by a billionaire owner seeking a tax handout, leading to the Chargers departing for LA. good riddance. See Also: San Diego’s moving companies have united in refusing to help the Chargers relocate.

Happy Birthday: Ten years ago, Netflix launched streaming video and changed the way that we watch everything.

Workers Paradise: An iPhone costs nearly $100k in Venezuela thanks to hyperinflation.

Bulldozer: Amazon is taking the next step in crushing America’s biggest fashion retailers by launching its own athleisure brand.

Chart of the Day

For sale starts are still going up…

But multi-family starts have begun to fall off…


Today’s Sign of the Apocalypse: The parent company of Chuck E Cheese is preparing the vile kids pizza joint for an IPO.  For those of you tempted to purchase stock in such a fetid enterprise, I’d like to remind you of the worst crimes ever committed at a Chuck E Cheese.

Con Man Gonna Con: Bernie Madoff managed to corner the market on hot chocolate in prison and drove up jailhouse prices for anyone who wanted some (no, I did not make that up).

Score: A Dutch groundskeeper for a professional soccer team drew a giant snow dong on the field during halftime of a recent game.

Landmark Links – A candid look at the economy, real estate, and other things sometimes related.

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