The Outlook for Construction Capital

By Keat Foong, Executive Editor

Financing will continue to be available for new multifamily construction this year, barring unforeseen circumstances, says David Rifkind, principal and managing director of George Smith Partners Inc.

After a rough patch, capital has returned to the multifamily new-build markets, at least in the gateway cities such as New York, Washington, D.C., Boston and Los Angeles. Indeed, “there is abundant construction financing for multifamily in core markets,” he says. According to Rifkind, in these areas, “there is easily three times the number of lenders operating in the new multifamily construction space at the end of 2011 as there was at the beginning of the year.”

What would make for the continued abundance of construction capital is the returned profitability of the commercial banks, as well as the tightening fundamentals of an already-strong multifamily rental market in the leading cities. The larger regional and national banks have received a mandate to grow their loan books, says Rifkind. They are once again seeking profits, and construction financing is a very profitable line of business for them, he notes. Furthermore, permanent financing also stands ready in the strong markets to take out construction loans, owing in large part to the existence of Fannie Mae and Freddie Mac.

The national and regional banks are the lending entities that are strong players in apartment construction financing currently, says Rifkind. Construction loan interest rates are currently “phenomenal,” he says. With LIBOR at 250 to 350 basis points, all-in bank loan rates are coming in at 3.25 percent to 4.25 percent. However, underwriting, which is performed also to debt yields, is very conservative. Loan to Cost is between 65 percent and 70 percent, and the pro forma incomes are not trended. “Banks do not allow the borrower to plug in rent growth during the construction and lease-up period,” says Rifkind.

Another source of construction funds, FHA-insured financing under the Department of Housing and Urban Development (HUD) provides construction-permanent rollover financing with terms of up to 40 years. However, there remains a backlog in FHA insurance applications, and an FHA loan currently can take 12 to 14 months to complete, says Rifkind. One advantage of FHA financing, though, is that this form of financing can go to smaller projects and the secondary markets that are often otherwise being ignored nowadays.

In the core markets, financing is available not only to the top and biggest developers, but also to the lesser-known ones, Rifkind suggests. However, the leverage limitations of the financing may bar the return of merchant builders for the time being, he says. “Most of the activity comes from owner/builders,” he notes.

All in all, the multifamily construction market is in the early part of the cycle, says Rifkind, and the outlook for continued capital availability appears clear at this point. “The market sector is not capital constrained at all,” says Rifkind. “This is a good time to come to the market with a great project.”