Show Me The Money

It is becoming readily apparent that the Banks, in general, are pulling back from ground-up construction. As we are in the market sourcing debt, we are hearing from our Bank contacts that:

1. “Our construction “bucket” is full for the year”;

2. “We are reserving our construction lending funds for existing clients”;

3. “We are late in the cycle so are not entertaining new construction loans”; and,

4. “The new Basel III regulations have increased reserve requirements so we are doing fewer construction loans as well as cutting back on our advance rates and increasing pricing”

So what are the options for developers and homebuilders in this environment? There are debt funds and hard money lenders that are still active. On the negative side, their rates are higher, generally in the low to mid double digits “all-in”. On the plus side, in many cases they will go further up the capital stack, decreasing your overall equity requirement.

As the Banks have scaled back on advance rates, we are also starting to see mezzanine lenders become more active in the space. They are filling the increasing gap between the senior loan and the traditional equity layer. This is more expensive than the senior debt, typically mid-teens “all-in”; however, less expensive than equity. Mezzanine lenders most often get a coupon and do not participate in the “ups” so, assuming the developer can fund the equity requirement internally, he does not need to share the upside.

In general, the current lending environment is pushing the cost of capital higher. It is important that developers and homebuilders incorporate this into their pro-forma when determining what they are willing to pay for an asset as well as the overall viability of the transaction.

Tom Farrell

Director of Business Development at Landmark Capital Advisors