Banks have pulled back sharply from construction financing, which can open the door for commercial mortgage brokers
Housing shortages have been widely reported by several outlets across the housing industry. Realtor.com cited that the US housing market is running roughly four million units short of what it needs.
The combination of many factors impacting the housing market continues to weigh on the confidence of builders. The latest numbers from the National Association of Home Builders released on Monday showed a streak of pessimism that mirrors the foreclosure crisis of the early 2010s.
According to the NAHB, single-family residential construction and land development loans have fallen off more than 50% below the 2008 peak of $204 billion.
The collapse of Silicon Valley Bank accelerated the retreat further, pushing regional lenders to tighten deposit requirements, reduce facility sizes, and lower leverage. However, for commercial mortgage brokers, that pullback created an opening.
Robert Trent (pictured top), CEO of Builders Capital, led one of the largest builders in Washington state. He now runs a private lender that has been working to fill the gap the banks left behind.
"The banks are really retreating from the space," Trent told Mortgage Professional America. "They're decreasing leverage they're offering to homebuilders, they are increasing deposit requirements, they're decreasing the size of the facilities they have. And essentially, the homebuilders are scared or concerned that the banks aren't going to continue to be there in a meaningful way for them to capitalize their homebuilding needs."
Changes after the financial crisis
Trent said the relationship between banks and private lenders in the construction space has flipped entirely.
"We used to be an overflow — their primary source of capital was the banks, and we were an overflow as a private lender to them," he said. "The inverse is now happening where they're asking for us to finance a lot more and have the banks as their overflow or backup plan."
The post-Global Financial Crisis (GFC) withdrawal of larger banks created a structural gap that regional lenders have not been able to fill, Trent said. Continued regulatory pressure from the FDIC on commercial real estate exposure makes a banking sector comeback unlikely in the near term.
Institutional capital has moved in to take up some of that slack, but Trent said finding the right home for it has not been straightforward.
"They're aggressively entering our space," he said. "All of the major name brands on Wall Street — the vast majority of them — are trying to deploy money into our space. I think the challenge they have is finding a reliable, scaled platform that underwrites the risk appropriately."
Why spec limits are a difference maker
Trent said the argument for private construction lending is not really about interest rates. It is about how many homes a builder can build in a given year.
Spec limits are where the gap shows up most clearly. A bank might cap a builder at four unsold homes at any given time in a 50-lot community. A private lender might allow ten.
"You can actually sell two houses a month as long as you have finished inventory," Trent said. "So if it takes you five months to build a house, we may allow you to have 10 specs. Basically, you start two homes a month. And by the end of month five, you've got two finished houses. As long as that market can continue to absorb those houses, you're going to be able to sell a lot more units than that bank allows you to."
Trent said builders who have bumped up against bank spec limits tend to understand the argument immediately once someone lays out the numbers.
"The banks are always going to be less expensive than private lending," he said. "But private lending will allow you to build more homes and create more revenue and more profits on a yearly basis. So if you're a home builder, what's more important? Are you going to save a few pennies on the dollar you're chasing, or are you chasing more dollars?"
After experiencing both sides of the builder equation, he sees the major advantage outside of the bank lending space. This can also provide opportunities for brokers to get more loans on more properties, instead of being limited by smaller spec limits from traditional banks.
"After using a private lender, I would never go back to a bank unless I was forced to," he said. "When you can make sense of the decisions being made by the financial institution you're borrowing from, it's just night and day in terms of what you can expect, how you can rely on them, and the ease of borrowing that money and focusing on just building houses."
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This article is part of our Monthly Spotlight series, which in June focuses on residential and commercial construction. Full coverage can be found here.
