When Linda asked me to write an article for the monthly SWMBIA newsletter I was honored... My head was full of ideas and I was really excited to get an opportunity to share with the builder community on a number of subjects throughout the year. Then the year happened. The first quarter of this year put loan originators who were doing volume of zero to 500k monthly in positions where they were putting together more loans in a month than they were doing in the entire previous year.
The rising tide lifts all boats and I was no exception. My business took me in and wrapped me up like some sort of chrysalis or cocoon for a while. It was exciting to be able to be of service and we saw tremendous success along with a feeling that we were doing something good. There were many times where I was able to cut three or four hundred dollars monthly from a person's mortgage payment or monthly bills. Yes, guidelines continued to tighten somewhat but there were still more people that we could help than the people we could not.
As the year moved into spring I noticed that something was missing. I was not meeting with the brave few who wish to explore the construction of a new home! Construction lending has been a large part of my business plan in the past so this was disconcerting. In visiting with my friends in the lending business (who are now coming out of "refi-bernation" like bears leaving their dens and seeing the sun for the first time in months!) I hear that construction lending has tapered for them as well.
In the past, we were able to finance a project and establish equity position based on appraisal value. SO: Regardless of cost...if a place appraised for 400,000 dollars...we could easily build the project for $320,000 and the client was left with a mortgage at 80% loan-to-value. This felt really good for the bank to know that the open market would bring 20% more than they had a loan out for. Clients felt good with this as well and some actually took 2nd mortgages to get to 100% of the value of the home and use the funds that were "tied up" in their home for something else.
A few years went by and we continued to put together construction loans for just about anyone who was interested. It was almost like the old 80/20 rule...about 80% who wanted to build a home were able to realize that dream with the money that was readily available. Now, things have switched somewhat.
Today's construction loans are getting back to where they were before and perhaps should have been all along. We see banks requesting some "skin in the game" in the form of land that has been owned for at least a year before the "appraisal value" of the land can be considered or 20% of the ACTUAL costs from the cost breakdown being required UP FRONT before the project starts. The name of the game: protect the investment. When banks allowed themselves to think of the "value" of their investment to be so much greater than the actual COST of the investment things were bound to get out of hand when the market began to tumble.
What happened? Homes were actually worth LESS than when construction started by the time they were done. Banks who were in a great position before (and often didn't require another appraisal) were upside down in homes that they thought they had 20% equity in. People realized they were upside down and walked away from projects they were right in the middle of leaving the banks to hold the bag. Many were over budget and unable to get MORE money for the perm. Unfortunately, the "easy construction money" also brought in many, many "builders" of questionable competence and though they may have been doing the best they could...budget and time line fell to them.
Banks needed to stop the hemorrhaging, so they did. Within a matter of months we saw up-front requirements changing at the "wiser" institutions and things were put to the place they are now where guidelines are still being fine tuned. Other institutions did not react to the trend and we have seen their demise over the last 12-18 months.
Where are we then? Today there seems to be some appetite still for new construction. Many of us have local bank relationships who are willing to go to 85% loan-to-value for new construction with the right borrowers. A friend of mine with another bank in another area has a local bank source willing to go to 90% loan to value. National banks have programs right now where they will go to 90% loan to value...if a client has an additional 10% set aside as a "contingency" along with 6 months worth of payments available after closing.
I am hearing from some of my builder contacts that it is really a matter of relationship right now. Looking at what losses a bank has suffered in the construction fall out can determine what kind of opportunity a builder may have within that bank. All banks I visited with agree: cash flow/cash position is very important right now when they are looking at the bigger picture. Relationships with their builders based on deposits, reputation and past performance are another key. Builders who stuck to the principles that made them great such as resource management, priority management, service delivery and responsible use of credit have found this market tough...but not unbearable.
There is still plenty of opportunity out there. Rates are VERY low historically on construction and permanent lending. Labor costs are down and buyers are coming to the table with more reasonable expectations such as the assumption that they need some of their own money to purchase. We are seeing more QUALITY though less QUANTITY of interested buyers. Consumer sentiment reported this morning at a national level is UP and it is generally believed that the “worst” is over in the equity markets (DOW is UP about 60% from where it was in early March.) Now we watch the labor markets. We expect the “shape” of the down turn to be less like a “V” though and more like a Bathtub…we may be where we are now for a while but for now: the volatility seems to have tapered off. Good luck out there.
