Opportunities for construction lending

Illustration: Mick Wiggins/Getty Images

After taking a hit post-recession, construction and development lending is accelerating once more, but community banks are proceeding with caution.

By Beth Mattson-Teig

Construction loans that all but disappeared in the wake of the recession are now making a comeback, and community banks are once again opening the capital spigot for commercial and residential building projects.

The sluggish economy and heavy load of problem real-estate loans took a toll on construction and construction lending. Bankers took a big step back, and many builders and developers had their hands full stabilizing existing properties where property values had dropped.

Many of these builders and developers were working on refinancing and trying to, over time, pay off their existing projects before they started building again.

Construction and development lending is still well below pre-recession levels. Yet activity is accelerating along with a stronger economy and improving real-estate market. FDIC-insured commercial banks and savings institutions reported $303.1 billion in construction and development loans on the books as of third quarter 2016. Although that is about one-third the volume that existed at the peak of the market in 2006 and 2007, volume has increased by about $100 billion over the past three years, according to the FDIC.

“We are very active in the construction loan arena,” says Kent A. Nelson, executive vice president at Brighton Bank, a $165 million-asset community bank in Salt Lake City, Utah. “It is a major part of our new loan production.” Last year, Brighton Bank made nearly $25 million in both commercial and residential construction loans, and about half the bank’s loan volume over the past two years has been generated by commercial and residential construction and development loans.

Brighton Bank is actively lending on both commercial and multifamily construction projects, including property repositioning and renovation with loan amounts up to $3 million. “A lot of our commercial construction opportunities in the last few years have come in the multifamily arena, because that market has been the hottest in our area,” says Nelson. For example, Brighton Bank is proving a $1.5 million construction loan on the renovation of a 16-unit apartment complex. The developer expects to double the rents when the property improvements are completed.

Proceeding with caution
However, even as banks are increasing construction lending, they are keenly aware of potential risks ahead and lessons learned in the past recession. The previous real-estate crisis resulted in a spike in commercial real-estate loan delinquencies.

FirstBank Florida also restarted its construction lending in 2015. The bank provided about $5 million on construction loans last year and anticipates a bigger increase for 2017. “We just feel that it is prudent practice to be a little bit more conservative on the construction side,” says Mahesh Pattabhiraman, senior vice president and commercial banking group head of FirstBank Florida. Parent company First BanCorp. has a total asset size of $13 billion, which includes FirstBank Puerto Rico with operations in Puerto Rico, the US and British Virgin Islands, and Florida. FirstBank is underwriting loans more carefully and focusing on deals with proven sponsors or borrowers. In addition, it is doing loans at a loan-to-cost ratio that is typically about 65 percent, although it will go higher for loans that have a very strong borrower or very high pre-leasing.

FirstBank Florida is preparing to close on a $10 million loan for an 80,000-square-foot mixed-use commercial project in Doral, Fla., that includes office condos and retail space. The office condo units are substantially presold, and the project is located in a very strong office market, notes Pattabhiraman.

“We have been very consistent in our underwriting procedures,” agrees Nelson. Pre-recession, many banks were offering construction loans with very little or no skin in the game in terms of equity, he says. Brighton Bank has always required that the borrower put cash into the project and has raised that requirement from a minimum of about 10 percent pre-recession to 15 percent to 20 percent on most deals today.

“We just feel that it is prudent practice to be a little bit more conservative on the construction side.”
—Mahesh Pattabhiraman, FirstBank Florida

Community banks are an important source of capital for developers that are seeking smaller balance loans. The bigger banks typically are less active on construction loans below $5 million unless they are looking to fill a CRA requirement. Added to that, some of the larger regional and national banks have been pulling back on construction loans and are more selective on projects due to concerns about concentration risk.

Small-project lending
Baker Katz is a retail real-estate firm in Houston that builds single-tenant and small shop retail space. The company has a short list of three local banks that it uses for its construction and acquisition financing.

Baker Katz likes to work with banks that have a good understanding of construction loans and can fund the draws easily. “We have had the experience where with some banks, it is very easy to fund the draw requests, and some banks it is not so easy and takes a lot longer,” says Neal Wade, a development partner at Baker Katz. Those delays can be frustrating, because it delays payment to the contractor and subcontractors and can potentially slow the project.

Recourse is another important component, as most developers like to limit their personal liability. Generally, most banks are offering 100 percent recourse through construction completion, and then Baker Katz looks for lenders that offer favorable, limited recourse that might range from 10 percent to 25 percent depending on the project and lender. The company recently completed an 8,200-square-foot retail building on the east side of Houston last November that was fully pre-leased to Chipotle, AT&T and Frost Bank, and Baker Katz secured a $3 million construction loan from Trustmark National Bank in Houston.

Recent and anticipated interest-rate increases could slow commercial construction lending activity this year. However, many bankers see a healthy pipeline ahead for 2017. “I think some of the developers are approaching this year a little more cautiously, but we are still optimistic that it will still be a good year for construction lending,” says Nelson. “We deal with a number of developers and builders and they all have projects planned for this year.”


Beth Mattson-Teig is a writer in Minnesota.

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