Capital Infusion: How to Optimize Forthcoming Construction Lending
Many areas of the United States are seeing a resurgence in construction starts, but the question remains whether any restart of the economy will be sustainable.
The lending industry has been heavily regulated since the Great Recession, and construction loans are not exempt from the regulation and oversight, which tends to chill enthusiasm for new lending. Although residential construction enjoys the relative availability of new construction funding, commercial and industrial lending is still hampered by an industry-wide fear of failure.
Added to the risk of loan-to-value ratios is the prospect that the project will not be built properly, on time or retain the value it needs after occupancy. Prefabricated buildings for distribution centers resulting from a bloom in “e-tail” may be exempt because such a need is still on the upswing and unfulfilled. In contrast, construction of apartments appears to be waning nationally as supply overcomes demand.
BRINGING VIBRANCY BACK TO CONSTRUCTION LENDING
Enormous sums of investment capital are still in need of a home, and the commercial mortgage-backed securities (CMBS) arena has become much more interested in initiating construction loans. CMBS is a means of investment by which large multi-billion-dollar trusts are formed, each packaging together various loans in a collateralized trust that is rated like other bonds.
For example, a life insurance company may be interested in purchasing very risk-free debt, and CMBS AAA bonds tend to fit that requirement. This type of investment relates to the construction loan industry because after 2008, CMBS funding dropped off dramatically, and now these investors in trusts are looking for new loans. Because not enough commercial loans exist in the marketplace, the CMBS investors have turned to the quarter of construction lending, even though the lenders for this type of funding have much less experience in the administration of construction funding.
Part of the reason for this is the recent onset of new regulations that require CMBS originating lenders to hold certain percentages of loans on their own books and not turn them over to the CMBS trusts. As a net result of these new “risk retention” loans, the originating lenders are expected to throw off abundant cash for construction loans looking for a home.
As recently as December 2016, J.P. Morgan announced the availability of $1.5 billion of new money construction loans. At a minimum, infusion of this level of capital will be something to watch to determine the effect on adjacent areas and to keep tabs on which U.S. regions will be most favored with the infusion of this new cash.
BECOMING ATTRACTIVE TO LENDERS
A contractor can add value to its business by becoming as loan-friendly as possible to a new commercial developer. This can be accomplished by developing a protocol that is uniform and highly user-friendly for neophytes to construction lending, such as CMBS lenders. The prospective owners can sell the contractor services as part of the pitch for the new lending, and everyone in the project benefits from the symbiosis.
The best protocol a contractor can develop to optimize the influx of money is to examine what type of construction is most likely to attract this new funding source. Certainly, retail and large-scale residential badly in need of remediation will be at the top of the list because commercial loan originations maxed out in 2006 and 2007, at the height of the loan bubble.
Contractors that market themselves as specializing in live-loaded properties in need of renovation and remediation will be the most attractive to the marketplace, and especially CMBS lenders who are in the process of taking back lots of previously mortgaged property in foreclosure or workout. Plenty of these properties have abundant deferred maintenance and need complete renovations as a result of borrower or owner neglect. Also, due to the rapid pace of change in the commercial market, contractors’ ability to renew properties for varied uses will serve them well, as will the creativity and ingenuity to accomplish these new uses and functions.
Also, a vast “cottage industry” has developed from investors who are purchasing properties from large auction sites such as auction.com. Having a membership to view the auction activity, targeted to a contractor’s geographic area, can immediately alert the contractor to what new owners are coming online and offer foresight of where new business will be developing for this type construction.
As for new construction, CMBS reporting services such as Bloomberg and CREFC will continue to report on the larger construction projects that are serving as the “risk retention” piece for the new investment capital turning into construction loans. In the months to come, time will show what the CMBS market lenders find most favorable, whether it is new types of experiential retail, entertainment venues, hotels, apartments, condominiums or something completely unforeseen.
A contractor’s website should highlight the ability to service owners’ needs and perform on sites financed with CMBS or risk retention lending. This should accompany a well-run protocol of submitting payment applications and delivering on-time percentage of completion, lien releases and contractor’s affidavits, all of which typically are required as funding progresses. The more stable and formulaic the payment approach is, the more value is added because new lending sources will be less familiar with these requirements.
This topic should have a placeholder for a six-month review because the infusion of new capital will be so large and so rapid that the prospects are exciting, but in large part lacking predictability on the front end. Contractors should search where this new money may be going now because this ship may sail fast and be out of sight before the end of the year.