Builders Looking to Repair Broken Home Finance System
Amidst growing signs that housing is on the mend, builders attending last month’s International Builders’ Show (IBS) in Las Vegas turned their sights on repairing a badly broken housing finance system to restore the flow of credit for home mortgages and acquisition, development and construction (AD&C) loans.
Builders also heard from multiple sources on how best to negotiate with lenders on working through problematic existing loans for projects that have succumbed to the negative forces prevailing to at least some extent in most parts of the country.
Major banks and traditional lenders, they were told, remain under the sharp scrutiny of the regulators and may not currently be reliable sources of financing for new residential projects. That may force smaller builders with viable plans to look beyond traditional sources of credit to investors, partners and even family and friends.
NAHB inaugurated a Partnership Pavilion at the show to put association members searching for financing in touch with not only banks, but alternative sources of funding, including investment and private equity funds. Thirty financial firms signed up to look at more than 200 project proposals that were submitted ahead of time and on-site, and the local builders who participated were encouraged that this approach will begin opening doors for their business as the recovery progresses.
The representatives from private equity funds who participated are accustomed to dealing with larger builders, and the pavilion put them in touch with “a whole new audience of smaller builders” who demonstrated that “there are a lot of projects out there that can provide a favorable rate of return,” said NAHB Vice President David Ledford.
Peter Hazeloop, an associate with Michael P. Kahn and Associates in McLean, Va., said that the pavilion was “starting a dialogue” that will help fill a huge gap between the strong returns and big investments that private equity is looking for and the small needs of the typical builder member of NAHB.
The 30 different firms his company works with tend to be based on Wall Street and typically hold $100 to $200 million in funds, Hazeloop said. About 75% of them are in the market for large deals, he said, “but 25% are more attuned to the smaller deals builders are looking for,” and are willing to fund lot development and construction.
Rand Roan, a principal of Plano, Texas-based Apogee Partners LLC, which helps builders and developers work with private equity groups and individuals to reorganize their debt, reported a “good experience” with the 60 to 70 builders he was able to meet at the Partnership Pavilion.
“Most of these are people who have been in the business for 20 or more years” and have been profitable most of the time, he said, but have run into problems over the past year in getting financing as the banks have slowed down their residential lending.
One builder in Albany, Ga., he said, who had the same relationship with his bank for 37 years, had never had a problem and had always been current with his payments, has suddenly found himself cut off. “Examiners are now telling him there’s not much they can do for him,” he said.
Roan said that builders visiting the pavilion were finding alternatives they hadn’t investigated on their own, often because they are in small markets where equity partners are not to be found.
As a result of participating in the pavilion, “we have been able to talk with people we otherwise would not have been in touch with,” Roan said, adding that he would be following up with at least half a dozen builders to further explore the possibility of funding their projects.
John Gonzalez, of CCF Multifamily in Houston, which specializes in funding HUD multifamily deals, said that he had received valuable leads from just about all of the 12 to 15 builders he had interviewed, calling most of them “rock-solid.” He said that “most were very, very legitimate, and shovel-ready at times.”
On the other side of the desk, builders were also reporting encouraging results.
“I learned a lot about equity partners and I think we made some good contacts,” said Lori Ferguson, of Osborne Development Corp. in Rancho Santa Margari, Calif. She said she had at least two confirmed appointments after Las Vegas to further discuss projects “we know can make money in this environment.”
“In construction financing, the banks are holding back and are very uncertain about what they will finance and the type of loan they will provide,” said Alie Chang, co-founder of the Pac Pacific Group in Santa Monica, Calif. “We wanted to explore additional financing sources other than what we already have.”
Alie said both of her appointments with private equity firms at the pavilion were “excellent.” In her first meeting, “we thought if we reduced the units and made the package smaller, maybe we had a better chance, but they were actually interested in a bigger package,” using existing units to refinance.
Joe Dahliwall, of Florida Suncoast Homes Inc. in Oldsmar, Fla., said he was looking to finish two two-story townhome projects in Tampa and St. Petersburg that were started before the recession hit but remain only half way finished.
“We do good stuff, quality homes and need funding,” he said. His current lenders “are dragging their feet,” he said.
Jay Shackford, a consultant at the pavilion, said that this effort is being continued beyond the IBS, and that NAHB is compiling a database of information on builder companies and their projects needing funding that backers can search. The pavilion is also expected to return to next year’s International Builders’ Show in Orlando.
Working With Banks
Home sales and production are expected to steadily improve this year, but activity is not likely to begin reaching its full stride until the end of 2011 and the year following, and participants at educational seminars at the show suggested that many small builders may have to tide themselves over for the short term by continuing to diversify.
While remodeling has emerged as the primary sideline of local builders attempting to weather the slump, the large supply of foreclosed properties peppering the landscape, including many that have not yet been returned to the market, represent a growing opportunity for builders, speakers said. Banks will increasingly be looking for industry professionals who are able to return these homes to marketable condition, and that is another reason builders should be cultivating good relationships with their banks.
Panelists who were on hand to provide builders with insights on how to negotiate with their lenders were not optimistic that banks will soon be returning to their normal volume of residential construction loans. In the meantime, they gave a number of pointers on how builders can make the best of a less than ideal situation.
Working With Banks
“There is no new AD&C lending available for us” from the banks, said moderator Marty Mitchell, vice chief executive officer for Mitchell & Best Homes in Rockville, Md. “But there are billions of dollars on the sidelines waiting to jump into the market.”
With housing starts beginning to turn upward, “there is a little more cash in the marketplace,” said Steven Camp, a partner at Gardere Wynne Sewell in Dallas. But he predicted “a 36-month hangover because of the high pool of foreclosures,” adding that “lenders are not going back to easy credit.”
Camp said that lenders have been pressuring banks to get residential development loans off their books. Along with other speakers, he indicated that the banks have become more restrictive in their lending to builders.
“The regulatory side will stay extremely conservative,” said Apogee Partners' Rand Roan. He cited “a disconnect” between what the Obama Administration is hoping to accomplish in increasing the availability of credit to small businesses and the regulatory constraints being placed on banks.
“The regulatory bodies have made a 180-degree turn in the way they allow banks to treat real-estate assets,” Roan said. The banks, in turn, “are trying to devise policies to work with people, but it’s tough.”
“Looking at the business model for lending to home builders, it is so broken they will have to push for alternative sources for the next couple of years,” said Melissa Hicks, Texas regional manager for RBC Builder Finance in Houston.
In working out problem loans and dealing with banks, Hicks advised bankers and developers to find out where they stand at the institution, and to accomplish that, “work your way until you find someone who is a business person.”
“Every bank has a different culture and you really have to know your banker,” said Camp.
In general, builders heard that they need to establish an open line of communication with their bank if they are running into trouble, need to provide their lender with as much relevant information about their company and the marketplace as possible and provide a plan for restructuring the loan that will be mutually beneficial to the bank and the builder.
When faced with “no cash, no income and no one showing up at the model, some builders throw their hands up,” said Bob Kline, principal, R.W. Kline, LLC in Scottsdale, Ariz. “The pressure is extreme; you have to keep your business going forward.”
It is in the best interest of the bank to keep an outstanding loan performing, said Hicks. “It destroys the bank’s portfolio when it’s not.”
As one example of a successful workout, Camp described a case in which a bank knew a project was going under and decided to provide potential home buyers with “very favorable financing terms for five years.” By making the homes “very marketable,” the bank was able to get the loans off the builder’s balance sheet and 18 months down the road there have been no buyer defaults, he said.
When the market is slow, and foreclosures are on the rise, Mitchell suggested that builders need to convince the bank that they are the best alternative for eventually reaching a satisfactory resolution and it is in their best interest to keep the builder’s job going.
In a separate program on alternative financing, Tom Stephani, president of Stephani Enterprises, LLC and Custom Construction Concepts Inc. in Crystal Lake, Ill, said that this is a good time to build custom homes but with appraisals a potential problem, builders need to be ready to provide up-front money for the project.
In these instances, Stephani suggested that builders should have the buyer carry the loans.
In terms of other alternative financing sources, he suggested finding:
- Landowners who need help.
- Failed or stalled projects; “banks don’t want to own or manage real estate but they have a lot in their portfolios,” he said.
- Business owners, who should be presented with a good business plan. “There’s tons of money sitting on the sidelines,” he said.
Stephani also urged builders to network to find potential investors, exploring such resources as their local home builders association, the Chamber of Commerce and former customers who might be looking for a partnership opportunity.
The Future of the Housing Finance System
In their deliberations on Jan. 21, the NAHB Board of Directors approved a resolution that set a significant framework for restoring and improving the secondary mortgage market and housing finance system.
“The implementation of major changes to the housing finance system, while intended to correct flaws in the previous structure, must be undertaken thoughtfully and carefully to avoid severe adverse consequences for home buyers, home builders, the financial markets and the U.S. economy,” the directors said in their resolution.
The resolution envisions a secondary market in which mortgages would be packaged and sold as securities, with the federal government establishing a fund to provide a guarantee of timely payment of principal and interest to investors in the securities. The secondary market entities that benefit from the federal securities guarantees would pay a fee to capitalize the fund, which would be designed to mitigate the federal government’s risk so that it would only be exposed in the case of a “catastrophic” occurrence.
“There should be continued availability of financing for long-term (at least 30-year) fixed-rate mortgages, as well as mortgage products with well-understood risk characteristics such as certain standard adjustable-rate mortgages and multifamily products,” the resolution said.
“There should not be overly rigid adherence to loan-to-value limits that results in inappropriate rejections of creditworthy borrowers,” the resolution said. And, “mortgage originators, lenders and investors should have appropriate accountability and liability for their instruments in which they are involved.”
NAHB leaders will continue to work on this crucial issue as the Congress and Administration move forward this year with legislative proposals on the longer-term future of Fannie Mae and Freddie Mac and the housing finance system.