The construction debt market has slowly but surely returned, though the lessons learned through the last downturn are informing today’s more conservative approach, said panelists at the "Digging for Dollars: Finding Construction Debt in an Up Market" session during the 2011 Multifamily Executive Conference.

Wells Fargo is one of the most active banks today, originating construction loans with a focus on multifamily deals. More than a third of all new construction loans the bank originated last year were apartment deals, and so far this year, that figure has climbed to 42 percent.

Beyond the strong fundamentals of the multifamily industry, Wells is bolstered by the availability of permanent debt takeouts available from the government-sponsored enterprises (GSEs). “The GSEs are doing their job, providing liquidity to the secondary market so that we can move on to the next project,” said Hugh Allen, senior vice president and mid-Atlantic division manager at San Francisco-based Wells Fargo. “It’s very difficult for us to find a home for office/retail/industrial at 65 percent leverage—it has nowhere to go. But we have a lot of confidence in multifamily because we also do Fannie, Freddie, and HUD.”

Allen noted that one big change in the last 18 months is the degree to which equity providers are making their presence felt in negotiations with construction lenders, a much different dynamic than the last boom period.

Indeed, the equity side of the equation returned much quicker than the debt side. Developers are looking to shore up as many lending relationships as they can, to mix and match for operational efficiency. For instance, Dallas-based Mill Creek Residential Trust has a growing new construction pipeline of about 3,000 units this year, and plans to up that figure to 5,000 in 2012. But finding the debt for so many deals will take myriad options.

“We have a heavy focus on trying to establish relationships with our key lenders, banks, and life insurance companies, to handle that kind of demand, and to provide capital for us through up and down markets,” said Eric Lezak, CFO of the West region for Mill Creek Residential Trust. “Clearly, equity is back—that market has fully recovered. But it’s taking longer to get larger debt deals done. The syndication market is not functioning the way it was at the peak.”

Careful approach
Borrowers and lenders alike are taking the lessons learned through the last downturn to heart. While leverage levels have increased over the last year, they certainly haven’t hit the 80 percent or more mark as they did in the last cycle. And many borrowers credit a conservative approach—irrespective of what’s available—for their continued success.

“We’ve always been in the 60 percent to 65 percent leverage range, even when 80 percent was available,” said David Lodwick, finance manager at Phoenix-based Alliance Residential. “That’s given us the ability to survive and thrive.” 

And the top lenders, like Wells and US Bank, continue to target the strongest, most well experienced developers. “In a word, it’s all about quality. We’re really focusing on track records,” said Steven Richard, executive vice president and southwest region manager at Minneapolis-based U.S. Bank Commercial. “It could be a mid-market company, or it could be institutional, but what’s their track record in terms of creating volume and executing? And we look very closely at contingent liabilities, but that’s no different than we’ve always been, and that’s why we were lending throughout all cycles.”

But many wonder if this careful approach is contagious. As multifamily developers exuberantly expand their pipelines, the fear is that some markets will get too frothy too fast. “I’m cynical about this idea that we have to rely on the capital markets for discipline—that hasn’t worked out the last 25 years,” said Richard. “The banking industry has a lot of stresses—banks are under pressure to build revenue, plain and simple. And we’re seeing a lot of competitors under pressure to grow assets.”