Construction financing: More money than projects
BY BRAD ZIGLER
Special Correspondent

Originally published June 23, 2003 in the North Bay Business Journal

NORTH BAY -- For residential builders, there's just been too much of a good thing lately. There's plenty of money around, but fewer places to do anything with it 'round the North Bay. Either there's no room to build, or, for some market segments, demand has waned.

“It's common knowledge,” says Homebuilders Association of Northern California executive director Charlie Carson, “that higher-end housing, whether new or resale, has softened. However, it is not my impression that lenders have changed their approach to their key builders.”

Despite lower interest rates, builders aren't looking to finance larger numbers of units at the upper end, either, as increased building costs often yield higher monthly carrying costs.

Larry Klaustermeier, chief credit officer at Bank of Marin, says his institution's appetite for risk on higher-end homes has flagged in the face of slowing sales. Going forward, the bank will require contractors to demonstrate “the ability to reduce sales prices or carry the properties for a longer period of time to allow for sale," he says.

Potential actions by federal and state regulatory agencies to protect threatened species, also has banks concerned, according to Mr. Carson. “Lenders need the assurance from the agencies and local governments that the several houses, or whole projects, aren't subject to slowdown for additional approvals and sign-offs.

“The same issue exists today as it did ten years ago in west Santa Rosa,” he points out. “Remember the vernal pools area that contained federally listed wildflowers?”
For Richard Cooper, Christopherson Homes vice president of finance, lending is pretty much in a steady state this year.

“I don't think things have changed much in the past six months, “ he notes. “Banks are still willing to do financing, but the slowdown in absorption rates at the high end has affected appraisals. For that segment, builders may be required to increase their equity stakes.”

Mr. Cooper sees a brightening on the horizon. “Interest rates have helped out tremendously, but, with the economic downturn, we haven't seen the higher-end traffic we once saw. I see it getting a little better as things turn around, as they seem to be," he adds.

Money for apartments
There's plenty of money for apartment financing, too, if you can afford the risk.

“The funding supply for multifamily projects has never been better,” says Mike Hilliard of Hilliard Architects in San Francisco. “But it's no secret we're in a recession. Rents are soft, and there are fewer renters.”

For developers of 16-unit and bigger projects, the best deals, according to Mr. Hilliard, are HUD-guaranteed loans, typically of $4 million-$5 million. “They're not just for affordable-housing units,” he explains. “HUD-guaranteed financing is also available for market-rate housing. Frankly, there's no other deal quite like them right now.”

Mr. Hilliard's firm is managing the HUD-financed remodeling of Ponderosa Estates, a 56-unit complex in Marin City. Conventionally, a builder obtains construction financing from a local bank, but because of the inherent risks of such projects, financing costs are typically high. Once the project is built and leased up, developers obtain "take-out," or permanent financing, often from a different lender.

“The beauty of HUD-guaranteed financing,” says Mr. Hilliard, “is that it's 'all-in-one' -- construction and permanent financing wrapped up in one loan -- and at a very low rate. You're paying 5.5%, fully amortized, over 40 years. It's also a nonrecourse loan, too -- a feature developers love.”

HUD requires the developer to establish a corporation or limited liability company to hold title to the property securing the loan. Only one project is held by the entity, so in the event of a foreclosure, the lender and guarantor look only to the secured property and have no recourse against any of the developers' other assets. Equity requirements, too, are lower than those of conventional multifamily project financing -- only 10%, rather than the typical 20%-30% required.

“Developers have been chary of HUD financing in the past because of onerous paperwork requirements and a ponderous bureaucracy,” says Mr. Hilliard. “That's changed dramatically. HUD officials, fearing potential cutbacks under the current administration, have become very keen to build up business.”

Kansas isn't like California
Another federal financing program seems set for change, according to John Frith, spokesman for the California Building Industry Association. FHA financing, long-limited to take-outs, may soon become available for construction. With loan limits currently set at $280,789 for single-family North Bay homes, such financing may have limited applicability in this ever-inflating housing market, however.

“Congress has tried, with some success, to raise the FHA loan limits to keep pace with the market,” says Mr. Frith. “What works in Kansas, of course, may not work in California.”