Apartment Builders Seeking Construction Loans Locate Willing Lenders

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Developers are willing to construct new flats with occupancies steady and rents increasing. Local and regional banks, as well as certain national banks, are eager to offer non-recourse construction loans to the appropriate sponsors, providing nearly as much leverage as borrowers had before to the coronavirus epidemic.

These banks are still being more careful about the borrowers they lend to and the apartment construction projects they fund than they were before the epidemic. However, banks’ interest rates have traditionally been low, and they have not set a ceiling on how low their loans may float. The additional conditions of the loans that banks provide are often not much different from what they gave prior to the epidemic.

“In terms of revenues, price, and recourse structure, everything is pretty darn similar to what we were seeing prior to COVID,” says Jay Wagner, executive managing director at Cushman & Wakefield.

Interest rates continue to be historically low.

According to Bill Leffler, senior vice president of capital markets at CBRE, an apartment developer recently obtained a very low interest rate on a construction loan from a bank to create a new apartment property—including a few single-family rental structures. The 48-month loan’s interest rate will float 225 basis points over the London Interbank Offered Rate (LIBOR), with no limit on how low LIBOR may fall. The 30-day LIBOR rate is now only a few basis points over zero. The loan will pay 60% of the building costs with no recourse.

Banks will go to 65% loan-to-cost for the same interest rate, but they need some recourse,” Leffler adds.

These terms are now comparable to what borrowers could get before to the epidemic. “We are seeing terms that are close to, if not already at, pre-COVID terms,” Wagner adds. “The major difference is the selectivity of the lenders available.”

During the pandemic, several of the major national banks drastically reduced their building financing. “At the local and regional bank level, several lenders have stepped up and taken market share away from major lenders.” That is where we see a lot more rivalry for the loans,” Wagner adds. “Thanks to the involvement of local and regional banks, we were able to push the conditions in a very advantageous direction.”

The low cost of finance is especially significant considering the constraints on yields for ground-up projects caused by high material and labor expenses.

However, in order to get a loan with such favorable conditions, borrowers must develop a strategy that impresses bank underwriters. “The key underwriting factors (after “sponsorship experience”) remain the health of the local market… population and employment growth expectations, and how that would allow for rent increase,” adds Leffler.

Borrowers are unconcerned about possible rate increases.

Apartment developers seem unconcerned about the possibility of rising interest rates while still making payments on a floating-rate construction loan.

“A change in interest rates of 25 to 50 basis points would probably not shift the needle that much on whether to construct or not,” says CBRE’s Leffler. “Rates would have to change far more drastically than anybody is anticipating before development would be hampered.”

Short-term interest rates, such as LIBOR, will almost definitely increase if federal authorities boost their benchmark federal funds rate from zero. During the sluggish recovery from the financial crisis, authorities maintained that rate at zero for years until gradually raising it to 2.5 percent in 2019. The 30-day LIBOR closely tracked the Fed Funds rate. Economists now anticipate a far quicker recovery from the epidemic. In June, the unemployment rate was already below 6.0 percent, thanks to the economy adding 850,000 jobs in a single month.

Developers may protect themselves against increasing interest rates by purchasing interest rate caps, a financial instrument in which an investor agrees to take on the risk of rising interest rates for a fraction of a percentage point, though the cost was even lower until recently. “Cap purchases were extremely cheap until this past week, and the price for a cap has risen slightly,” Leffler adds. Even at these low costs, developers have generally avoided using limits unless required by a lender.

“It isn’t really influencing developer decision-making processes,” Leffler says. “The most pressing problem for development is the rise in building prices and how this affects return-on-cost measures… despite the fact that lumber prices have declined in the last week or two.”

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