Where Is The Cheap Real Estate Capital?


The cost of capital is helping keep affordable housing out of the hands of consumers. It is not news that housing markets throughout the country are undersupplied with new product and that demand generally exceeds supply. In some cases, home prices have been pushed above previous peaks, which is making room for apartment rent increases and a general feeling that homeownership rates will permanently shift lower. The challenge is that affordable new homes are not being built. Our Managing Director Steve LaTerra argues that if significant amounts of affordable for sale housing were available in most metro areas, the homeownership rate would be significantly higher. Why can’t our industry produce product that the market desperately needs?

Over the last 30 years there have typically been low cost providers of capital for developers and homebuilders to access, such as savings and loans (S&L) or banks supported by government insurance programs. With this inexpensive capital, builders and developers could limit the amount of expensive equity required to finance a deal and deliver appropriate risk adjusted returns to their capital partners. Today, there are no S&Ls and there is preciously little available bank debt to support new housing. Equity return requirements are simply not achievable without some form of affordable leverage. To make matters worse, reserve requirements resulting from the Dodd-Frank Act are higher than ever, which will keep banks out of the market for the foreseeable future. So, where does this leave us?

As it stands, inventory levels are lacking and they are not expected to improve quickly enough to offset demand. This puts upward pressure on pricing and decreases the risk of investing in the space, but does little to address the country’s housing shortage. Private lenders have emerged to fill the void left by traditional banks, but private loans are not much cheaper than equity and are not a permanent solution to the issue. Unfortunately, the answer is likely political.

Banks want to do your deal. They want to lend to home builders and developers. After all, in the 1990s, acquisition, development, and construction loans (AD&C) accounted for 7-10% of the balance sheet of the largest banks in the country, and these loans were highly profitable. Banks recognize this, and in some cases bankers are as frustrated with the current situation as developers and builders. However, a banker’s ability to provide AD&C money (as it’s known) is limited by regulations of the Federal Government. The regulating agencies (FDIC and OCC) have placed significantly limiting restrictions on banks, which some might say have unnecessarily limited lending to the home building industry.

With the election of Donald Trump, a free market proponent, there is some question as to the future of GSEs, like Fannie Mae and Freddie Mac. Without these programs in place, lending to the home building industry would likely be even more expensive. Some may overreact to the threat of a system overhaul; however, let’s not forget that Trump is a real estate entrepreneur and will likely support policies that are ultimately favorable to our business. Time will tell, but it’s clearly too soon to assume the worst.

Contact us to discuss how we can help you navigate the world of capital.

Steve LaTerra, Managing Director – Advisory Phoenix