ONE-MONTH LIBOR RATES
”¢ Dec. 2008 - 1.9%
”¢ Oct. 2008 - 3.9%
”¢ Aug. 2008 - 2.5%
”¢ June 2008 - 2.5%
”¢ April 2008 - 2.7%
”¢ Feb. 2008 - 3.1%
Short-term interest rates have fallen steeply from their highs in September, making construction financing more feasible.
Bankers still pick up the phone for mortgage brokers like Matt Bolen of Kirkland, Wash.-based U.S. National Mortgage.
In December, Bolen was putting the finishing touches on a $2.1 million construction loan to build 21 new apartments in nearby Woodinville.
“Small regional community banks will still lend,” he says.
Despite frozen credit markets and the near failure of the banking system in October, community banks are still in the business of originating construction loans sized under $5 million, though they are much pickier about who they lend to.
For the apartments in Woodinville, for example, the borrower is working closely with Coastal Community Bank to convince the bank that the loan can be underwritten responsibly.
That's a sharp contrast to the kind of attention borrowers received before the crisis.
“He would have had six to 10 community banks bidding for his business a year ago,” says Bolen.
Lenders more cautious
Funding of small construction loans ground to a halt during the crisis months of September and October and is just coming back to life, experts say.
“Everybody—both lenders and borrowers—has suddenly become very cautious,” says Kevin Kleen, vice president of HomeStreet Capital in Seattle.
As of early December, the last small construction deal HomeStreet closed was a $2.3 million mortgage to perform a deep rehabilitation of the Sherman Apartments in Seattle.
That deal closed in August. “I'm not aware of us getting any inquiries for September or October,” says Kleen. “People are putting projects on hold.”
In a typical month before the crisis, HomeStreet would get five or six requests for construction financing from small multifamily developers, according to Kleen. “Typically, one or two would close,” he says.
The credit crisis and the condominium bust have created challenges for small banks, experts say. Some made construction loans to condo properties that have since defaulted. Others have been criticized by federal regulators like the Office of the Comptroller of the Currency for having too many commercial real estate loans on their books. And all participants in the apartment markets are aware that the country has entered a recession.
However, these challenges have not pushed small banks out of the small loan business. Experts interviewed for this story agree that smaller banks are interested in finding solid projects to lend to and that some developers are actively looking for new deals.
“Smaller community banks are still largely active,” says Bruce Minchey, chief underwriter for KeyBank Real Estate Capital's Federal Housing Administration program. “They really aren't as burdened by these subprime loan assets.”
“I can't think of one local bank that's out of the market,” adds Janet office of mortgage banker Holliday Fenoglio Fowler, L.P.
Interest rates relatively low
Attractive interest rates have helped to keep borrowers interested.
In November and December, low benchmark rates helped to make up for the high interest-rate spreads charged by banks. “It's kept [overall] rates very attractive,” says Krolman.
Banks now charge interest-rate spreads ranging from 275 to 350 basis points (bps) over the benchmark London Interbank Offered Rate (LIBOR) for small construction loans, with even higher spreads of up to 400 bps for harder-to-underwrite deals, says Krolman. That's up from spreads around 150 bps over LIBOR in 2007.
Banks are tightening the underwriting of their small apartment loans and are generally only lending to the best deals. “They can really pick and choose,” says Krolman.
The size of the loans range between 65 percent and 75 percent of the projected value of the property, down from as high as 80 percent a year ago, says Krolman.
Lower leverage will protect banks if prices for stabilized apartment communities fall, as many lenders think they will, notes Bolen.
Banks are also demanding that borrowers pledge more than just the land under their project and some equity as collateral for a loan. They also require recourse of at least 50 percent to 60 percent of the loan value, according to Krolman.
That's a big change from a year ago when many banks offered non-recourse construction loans.
Also, both banks and borrowers are looking for reassurance that permanent financing will be available once construction is finished. “We don't like to have a construction loan only,” says Bolen. Instead, many borrowers are looking for “mini-perm” loans that can roll seamlessly into permanent financing. These loans protect borrowers and lenders in case the market for permanent financing radically changes before the term of a construction loan runs out.
Notes Bolen, “That way, if Fannie Mae's not there in 18 months, at least we have some breathing room.”