5 Key Financing Strategies for Residential Developers
The aftermath of COVID, inflation, rising interest rates, supply chain issues and geopolitical events have all combined to create a perfect storm for residential developers and sponsors. They face a difficult operating environment in the housing market, both in single-family and multi-family developments. Explosive demand has driven up house prices, dramatically increased rents and led to critical housing shortages in some markets. Yet developers have been stymied by rising costs, material and labor shortages, and project delays.
In March, the US Census Bureau reported housing starts had rebounded, rising 6.8% in February to 1.769 million, the highest since June 2006 and an above-market forecast of 1.69 million. Meanwhile, the National Association of Home Builders said its measure of single-family homebuilder confidence fell to a six-month low.
According to the National Multi Housing Council’s quarterly apartment construction and development survey released in March, 89% of developers experienced construction delays, of which 85% involved both start-ups and permits. In the survey, 98% of respondents said they were affected by material shortages and 100% reported material price increases, with a 45% increase for lumber alone. Ninety-two percent said transactions had been revised up in the previous quarter, which also increased costs.
These trends show little sign of faltering as we move forward into 2022. According to data from the National Association of Realtors, home prices hit a new high in March as rising mortgage rates slowed the pace of home sales, which were down 2.7% from February and 4.5% from March of last year. High home prices and a lack of inventory have pushed some buyers into the rental market, where prices have soared above pre-pandemic levels. In April, the national average rent rose another $15, according to Yardi Matrix’s survey of 140 markets.
In this climate, with demand still strong and supply still limited, there are a variety of strategic factors to keep in mind that will help move your project forward, both from an operational and financing perspective. Here are five important considerations:
1. Look for land that is already authorized
Purchasing or using licensed land will save you valuable time – and money – in the development process and allow for a faster development start.
2. Plan for more lead times
In our experience, projects that would usually take 18 months now take 24-30 months to complete. You need to plan and plan for more time in your development and construction schedules. Consider ordering critical path items earlier than usual to reduce construction delays.
3. Liquidity is crucial
It is not just the price of wood that has increased exponentially. Appliances were up around 7%, for example. In the NMHC survey, 55% of respondents reported higher than expected labor costs. Overall, with inflation and ongoing supply chain shortages, you should expect your costs to increase by 14-20%. In this context, liquidity is crucial. Generally, lenders prefer to lend to sponsors who have experience of real estate cycles and those with deep pockets, thus increasing the chances of project success.
4. Choose your partners carefully
Current circumstances may dictate the need for additional project partners. You should carefully evaluate and select your partners to ensure that they have the same long-term goals and that they will materially contribute to your project, in terms of financial means, portfolio experience or local market expertise.
5. Lock in your interest rate
The Federal Reserve raised interest rates by a quarter point in March, with a further increase of half a point in May and has planned further increases to keep inflation under control. Yet interest rates remain historically low. In this rising rate environment, you should consider locking in your interest rate for as long as possible. Even at today’s higher rates, fixing the cost of servicing your debt will allow you to increase your margins as rents go up or projects move faster.
The effect of COVID on housing supply and demand reinforced by the impact of geopolitical events has led to an unusual market. Developers and developers planning for these contingencies can still capitalize on what is expected to be strong housing demand in the future.
Douglas Rutley is senior vice president and head of real estate for BHI Commercial Bank, the US division of Bank Hapoalim.