The market for construction financing is “pretty fickle right now,” a stark contrast from just a few years ago when the lending spigot for developers was flowing freely, according to Ari Dobkin, managing director of Meridian Capital Group.
“The funny money for construction just isn’t out there anymore. Lenders are hyper-focused on the borrower’s balance sheet, their experience doing construction and their ability to successfully fill up a building,” remarked Dobkin during a capital markets update panel session at InterFace Seniors Housing Northeast in Philadelphia on Nov. 15. The daylong conference held at Hyatt at the Bellevue hotel in downtown Philadelphia attracted approximately 200 industry professionals.
In addition to Dobkin, other panelists included John Randolph, senior mortgage banker, KeyBank Real Estate Capital; Frank Cassidy, vice president of originations at Berkeley Point Capital; Trace Wilson, director, Prudential Mortgage Capital Co.; and panel moderator Lee Delaveris, director of seniors housing and healthcare for RED Capital Group.
Dobkin joked that in the past he has fielded some unique requests from borrowers at industry conferences, including the following: “I own a bowling alley and now I want to build a seniors housing project on top of it. Can you get me 90 percent loan-to-cost?”
While the interest rates for new construction haven’t significantly shifted, lenders have pulled back on the amount of leverage that they are willing to provide today, according to Dobkin.
For example, a few years ago lenders may have gone as high as 75 percent loan-to-cost for a project that includes limited recourse and a completion guarantee. Now lenders are more comfortable providing a construction loan at 65 percent loan-to-cost, or they may go as high as 70 percent for developers with a proven track record. “But lenders don’t really want to push leverage anymore,” emphasized Dobkin.
One source of capital that borrowers should strongly consider today when pursuing development opportunities is their local lender, said Randolph of KeyBank. “With KeyBank being more of a national lender, we’re not really good at construction financing. But the lender that is there in the backyard — who knows the real estate and has an operation set up that can handle the asset management and manage the construction draws — is probably better suited for a developer to get its project built.”
All eyes on interest rates
The spike in the 10-year yield following Donald Trump’s upset of Hillary Clinton in the U.S. presidential race has raised the question of whether borrowers should lock in fixed rates or opt for floating rates.
On Election Day, Nov. 8, the yield of the benchmark U.S. 10-year Treasury note closed at 1.85 percent. By Nov. 14, the eve of the InterFace Conference, the yield had jumped about 40 basis points to 2.26 percent.
“We locked in an interest rate for a borrower yesterday and the rate was about 45 basis points higher than it would have been the day before the election,” said Randolph of KeyBank Real Estate Capital.
“In reality, nothing has changed in the economy in this last week other than we have a new president-elect. I think it’s just very reactionary to the news of what happened and what Donald Trump may want to try to implement,” added Randolph.
Trump has proposed at least $500 billion in infrastructure improvements over several years to rebuild America’s roads, bridges and airports. He also has vowed to create 25 million new jobs over the next decade and lower the business tax rate.
“That could create inflationary pressure,” said Randolph. “But again, nothing has changed with the economy. At some point in the near term, all we are is just one unexpected news story away before there is going to be a flight to quality back to Treasuries.”
Dobkin of Meridian Capital said that he expects interest rates to settle at about 20 to 25 basis points above their pre-election levels due to uncertainty in the marketplace following Trump’s victory. “You are always going to have that gray area of what the new policies are going to be.”
It’s also difficult to know what Janet Yellen, chairwoman of the Federal Reserve, is planning, added Dobkin.
A month after the InterFace Conference in Philadelphia, the Federal Reserve’s interest-rate setting committee increased the federal funds target rate by 25 basis points to a range of 0.50 to 0.75 percent. (The fed funds rate is the interest rate banks use to lend to each other overnight.) It is only the second time since 2006 that the U.S. central bank has raised interest rates.
Economy still growing
The committee pointed out that the economy is still strengthening, albeit slowly. The U.S. economy has expanded by about 2 percent over the last six years, and the national unemployment fell to 4.6 percent in December. Fed officials predict three rate hikes in 2017.
The wildcard affecting long-term interest rates in the United States is global capital, according to Delaveris of RED Capital. “It’s really had little to do with the U.S. and more about supply and demand of capital and negative interest rates in Japan and trouble in Europe.”
— Matt Valley