The COVID-19 conundrum: Money is available for new construction projects, but few innovate
Even in a coronavirus environment, there is money available to build new projects; what is rare is finding an owner ready to innovate.
This is the observation of several observers who have noted a shortage of new construction projects to come on the market. Lenders and financiers still want to support good projects, but fewer developers are willing to take the risk during the continued economic uncertainty of COVID-19.
“This is the real crux of the matter,” said Frank Cook, national program director, construction risk at EBI Consulting, a construction consultant based in Burlington, Massachusetts. “Funding is available, but many owners, investors and developers are playing the wait-and-see game. Projects that were in the works before COVID have moved forward for the most part, but owners have since hesitated to launch new projects. “
Indeed, according to Dodge Data & Analytics, total housing starts for 2020 fell 15%from the start of the year through July, with a 25% drop in non-residential housing starts. Non-construction starts, which include gas pipelines, utilities, environmental public works, highways, bridges and other infrastructure, also fell 20%.
The result was a decrease in the order book for entrepreneurs – the number of jobs they have signed, but which have not yet started – and a more competitive bidding environment for the smaller number of projects that are moving forward.
It all starts with the land
Part of the problem with the dwindling number of new projects entering the market has arisen on the land side, the ultimate starting point for any construction project, said Taylor Mammen, senior general manager of the company’s Los Angeles office. RCLCO real estate consultancy. Homeowners are dragging their feet to secure land deals that were underway before the pandemic, to buy time until a clearer economic outlook emerges.
“The developers are trying to delay the final closure of the land for as long as possible,” Mammen said. “In many cases, they have reached the limit of the patience of the salespeople.”
Mammen ticked off three factors contributing to the decrease in the number of new construction projects in the market, but funding was not one of them.
“First of all, there were some deals that got killed, so it had some impact,” Mammen said. “Second, anyone who can extend the land closure does so. And third, it has been difficult to start and make a new deal in an environment where people cannot travel, and it takes longer to get responses from planning departments. There are so many more things clogging the gears to move a project forward. “
Lenders are back in the game
Indeed, while contractors complained at the start of the pandemic that banks had withdrawn their construction loans, preferring instead to administer risk-free loans for the federal government’s Paycheck Protection Program (PPP), Observers say there is an urgent need to strike new deals now, while the lending criteria window is still open.
“What I hear from lenders is that they want to make loans while they can,” said Nikole D. Garcia, lawyer in the real estate and loan transactions practice at Trenam Law, based in Tampa, Florida. “There is a feeling that lending could tighten at any time, so it’s a mentality to make hay while the sun is shining. There is a bit of a frenzy to get loans and projects started in case conditions get worse. “
In Nashville, Tennessee, Built Technologies, a construction loan administration software provider whose customers include 26 of the top 100 construction loan banks, according to the company, business has been buoyant in multi-family sectors. and residential, and in some areas of commercial construction. .
“On the lending side, we saw over 3,700 new construction loans start through our customer base in July,” said Jim Fraser, Built’s director of CRE strategy. “However, this is heavily influenced by the idiosyncratic market conditions and the type of project. Banks and independent mortgage lenders process new construction and renovation loans when it makes sense. Architects, general contractors and subcontractors all enthusiastically submit bids.
Private money open for business
For Brett Forman, executive general manager of the Palm Beach, Florida office of private commercial mortgage lender Trez Capital, the lending window has recently reopened as well.
“We definitely stopped lending for a while and just managed the assets, but we’re open again now,” Forman said. “We want to do smart multi-family transactions and smart construction for multi-family, in areas we have always focused on.”
Case in point: Its credit committee has just approved an application for a new, eight-story, $ 5 million multi-family project in Fort Lauderdale, Florida. The deal has yet to be approved, but the initial green light is there.
“We are starting to come back to the market and support what we think are good projects in good demographics, with more experienced than less experienced sponsors,” said Forman.
Good deals in the right sectors
True, owners and developers bring new projects to market in selected sectors. While many observers say hotels, retail, restaurants and offices have been suspended indefinitely, the increase in online commerce, medical research and demand for non-urban housing since March has resulted in an increase in construction activities.
“New transactions are being made in data centers, life sciences, industrial distribution centers and multi-family buildings,” said RCLCO Mammen. “The percentage of overall construction activity in these four categories is high, but you see an overall reduction in activity. “
Shane Napper, president of construction in Grand Rapids, Mich., Rockford Construction, also sees notable activity in two other areas.
“We’re building a ton of grocery stores, and it’s been fantastic,” Napper said. “People spent a lot more on groceries during COVID. “Another bright spot is K-12 education, which is usually funded by voter-approved bonds.“ K-12 has gone crazy, in a good way, ”Napper said.“ Bond programs are passing through. like crazy. “
Nonetheless, Garcia of Trenam Law said projects moving forward need to cross a higher bar.
“A good project is still a good project, even in this environment, “Garcia said.” Some industries, such as food service and hospitality, will be more difficult to sell and subject to higher underwriting criteria, but with the right team of owners, level of experience and guarantees, there is money available. “
On the sidelines
But while new project funding is available, there are hurdles for developers who want to tap into it. On the one hand, money, while cheap, is not free. In addition to stricter overall loan criteria and only working with the best sponsors, lenders also put in place workarounds to protect themselves in the event of a problem.
“Even though the banks are lending what is essentially free money provided by the Fed, they are raising rates for many of these areas, in order to provide a cushion and a greater margin for error,” Mammen said. “And even if they don’t mark up the price of silver, they put floors on their benchmark rates, to maintain a return on their capital.”
For homeowners, that means bank rates on the low-end range between 3.25% and 4.25% on the best projects, sources say, and between 8% and 12% on private lenders. In a post-COVID-19 world, however, developers also need to think about the additional costs pandemic mitigation adds to a project, such as social distancing and other new worksite protocols.
As the costs of these steps materialize on job sites, they also find their way into negotiations between owners and contractors.
“As I prepare the contracts, owners and contractors are certainly focusing more on who is going to absorb the COVID risk,” said Joshua B. Levy, a partner who leads the construction practice in Kansas City, Missouri. Husch Blackwell law firm. “People are really sharpening their pencils to review these clauses.”
Taken together, all of this means that even with the wide availability of funding; even with money at historically low rates; and even with contractors submitting more competitive bids, developers still find reasons not to launch new projects.
“There is money on the sidelines ready to jump in when there are opportunities,” Mammen said. “But the work itself to move on to a new development and construction project is more difficult. Despite having fairly good liquidity from the banks, this turns out to be more expensive than you first purchased as a developer.