By Ben Miller, Co-Founder & CEO, Fundrise | Commentary
Posted on Globest.com
Now, those same borrowers can secure loans for 75% to 85% of the total project at four to eight percent interest rates, dramatically cutting the cost of borrowing by nearly two thirds. And this trend will stretch far beyond single-family home development. We will see lenders finance every asset class, as long as there is cash flow in place, or a strong business plan to increase returns.
Largely driven by a recovered housing market and low interest rate policy from the Federal Reserve, the lending environment has seen a remarkable change. Traditional banks have returned with gusto to capital markets and are making more aggressive assumptions. In 2012 and 2013, lenders were hesitant to provide financing for commercial real estate construction, even in top markets, often limiting loans to less than 65% of total costs. Banks are now handing out term sheets for more than 80 percent of total costs – including in secondary and tertiary markets.
To put it another way, if a $30 million multifamily housing project previously required $10 million of equity from the borrower, now banks are willing to lend at much higher levels and asking for only $5 million of equity.
Thanks to low Fed fund rates, bank financing is also as cheap as it has ever been, usually close to 3% annually during construction. As a result, a developer could borrow $25 million for a $30 million development and only pay roughly $750,000 in annual interest to the bank—significantly less than what they would pay for the $5 million in equity needed, typically requiring close to 20% returns per year.
Simply put, banks will give real estate companies nearly all the money needed for a project (around 83%), and get paid less in total than the equity (17%).
Imagine if you developed a $200,000 apartment building with a $34,000 down payment, and then owed the bank less than half of the rent you received each month. You would get to own the property and keep more than half of the rent, while putting up only a sliver of the total cost. What would happen? Well, a lot of people would start building apartments. That’s now happening.
There is even a drive now to build in secondary markets. It’s been reported that Nashville will have 4,327 apartments come online this year. Charlotte, San Antonio, and Dallas are next on the list.
Furthermore, the Urban Land Institute predicts that, even with the construction increases expected this year, there will still be a lack of supply to meet demand—which will further fuel development.
So, we expect to see a lot of new construction in the coming year—and in new markets. The lending environment has led to the rise of a builder’s economy, where the rational economic actor is compelled to build.
A relaxed Federal Reserve policy has led to aggressive lending, undoubtedly spurring growth and development, as well as further institutional real estate investment.
What will happen to these new projects if confidence in the global economy rises and base interest rates quickly move up? Though interest rates are expected to rise this year, it is anticipated that they will do so slowly, unlike the sudden spike seen by borrowers in 2013. According to the Commercial Real Estate Financial Council’s 2015 Market Outlook Survey, 69% of borrowers expect rates to increase, but there isn’t a whole lot of concern about it.
In the meantime, real estate developers around the country are seeing green (lights).
Ben Miller is co-founder and CEO of leading real estate crowdsourcing platform Fundrise. The views expressed in this column are the author’s own.