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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   December 2017

Capitalize on Construction

Declines in residential purchases can boost multifamily construction-investment efforts

Capitalize on Construction

No one is surprised that interest rates are going up. After hitting all-time lows for an extended period of time, there was only one direction rates could head. At the same time, mortgage rates overall are still very low compared to historical averages.

These days, the most pressing pressure on commercial mortgage brokers and lenders isn’t the concern that interest rates are poised to head upward. Rather, on the commercial end — and particularly for larger projects — the challenge these days is to find some creative alternatives to traditional loans, depending on the type of project and the financing requirements relative to the equity invested. This can be especially true of construction financing.

The housing bust and the recession that followed left an indelible mark on the manner in which the average person or family purchases a single-family home. Gone are the days of no income-verification loans. Regulators now agree that it makes good business sense to know whether the person borrowing money actually has the ability to repay it.

In this environment, commercial mortgage brokers should analyze the impact and role of construction financing as it relates to projects in the multifamily sector and also examine how closing more loans will raise the satisfaction levels of the lenders and borrowers they do business with.

To avoid any appearance that the federal government is careless with taxpayer money, new lending restrictions typically require homebuyers today to make significant downpayments on residential home purchases. The problem with that new normal — although it makes perfect fiscal sense — is that most individuals on the lower end of the income scale do not have enough available equity to meet the newer lending requirements. As a result, many of these potential buyers cannot qualify for a home loan, even if they have the income to accommodate the calculated mortgage payments, taxes and insurance.

Low-income homebuyers will likely continue to find it difficult to qualify for a mortgage because of a lack of available equity. 

With the likelihood of a home purchase decreased, many of these potential borrowers are forced to rent instead of buy. There are other factors that go into this, beyond the difficulty of saving for a downpayment. Those include larger amounts of student debt among millennials and the increased relocation flexibility renting offers.

Low-income homebuyers will likely continue to find it difficult to qualify for a mortgage because of a lack of available equity to invest in a home purchase. Under current lending requirements, there is little that mortgage brokers and originators can do to assist. This does provide an excellent opportunity, however, for the construction of multifamily rental properties.

To develop these projects, borrowers — in this case, owners or developers of multifamily properties — not only need a commercial mortgage loan, but they also typically need construction financing. For most of the last 10 years, this required both a short-term construction loan and permanent financing upon completion of construction, but some lenders have recently reported that single-close, construction-to-permanent loans are making a comeback.

Lower inventory supply

The increased flexibility of a construction-to-permanent loan is important, especially in a market of generally rising home values. Mortgage brokers should recognize the recent availability of construction-to-permanent loans and, in the right circumstances, make them available to clients working in the multifamily rental sector.

This is relevant because, in a rising-rate market, the value of the completed and improved property often exceeds the acquisition and construction costs. The increased property values greatly enhance the loan-to-value (LTV) ratio. The additional equity in the property makes the conversion to permanent financing attractive to the lender and buyer, as well as the mortgage broker who is looking to satisfy both parties.

The typical inventory of existing homes for sale is usually enough to last for about six months. Across the country, however, available inventory is significantly lower than that. In central Florida, for instance, recent reports indicated the market was at an extreme low of 3.42 months of housing inventory supply. That’s simply not enough available inventory for all the willing homebuyers to purchase the homes they want.

This reduction of supply has the correlating effect of driving up home prices. Higher prices, of course, drive away some potential buyers. Add in the fact that interest rates are on the rise and this situation is bound to self-regulate one way or another: Either the allure of higher prices will entice more sellers to list their homes, which will increase available inventory and likely drive down home prices because the available inventory will increase, or potential buyers will decide to avoid the marketplace. If rates go high enough to chase away a significant number of buyers, then prices will likely decrease. Until the housing market does adjust over the longer term, however, the demand for rental housing and multifamily construction projects is likely to remain strong.

Construction by the numbers

Associated Builders and Contractors (ABC) calculates a figure called the Construction Backlog Indicator (CBI). According to ABC, the CBI “is a forward-looking national economic indicator that reflects the amount of work that will be performed by commercial and industrial contractors in the months ahead.” ABC defines backlog as “the amount of work, measured in dollars, that construction companies are contracted to do in the future.”

Future indicators show that until 2019 or 2020, at least, the construction industry is poised to remain steadily busy.

As the CBI’s value rises, theoretically, contractors should be more comfortable in regard to their short-term economic outlook. Excessively small backlogs, however, imply that contractors are running short on work and need to identify and secure additional sources of future revenue. This past October, ABC reported the CBI fell to 8.6 months during second-quarter 2017, down 4.1 percent from first-quarter 2017. The second-quarter figure, however, was up 1.4 percent year over year.

Backlog increased significantly in the past first quarter, however, so there is a common thought that the construction industry is in a historically significant period of economic growth. Yes, there is a recognized shortage of skilled construction labor, resulting from both fewer entrants into construction fields and the departure from the field of seasoned construction workers who found themselves without jobs following the Great Recession. At the same time, future indicators show that until 2019 or 2020, at least, the construction industry is poised to remain steadily busy with increasing revenues and profits.

Because commercial mortgage brokers can anticipate their clients will need loans to purchase newly constructed multifamily buildings, they also can anticipate a significant increase in commercial lending, both for financing these projects during construction and for obtaining permanent financing. Thus, commercial mortgage brokers and lenders operating in the multifamily sector are likely to see both an increasing demand for mortgages as well as increased competition to lend money for projects in the sector.

•  •  •

Overall, the outlook for commercial mortgage brokers remains positive, the construction industry remains strong, and the backlog of commercial and industrial construction projects is on the rise. Making the situation slightly more challenging for brokers, however, is the fact that rates are rising and forecasts generally indicate rates will continue to increase.

Despite the upward momentum with interest rates, amplified by the near-term expectation of further rate hikes, by historical standards, rates remain low. Because of the positive future construction indicators, mortgage brokers are likely to find opportunities in the multifamily sector for the foreseeable future.


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