The uncertainty of the future makes loans more affordable for developers
BY BILLY OLSON
When COVID-19 was declared a pandemic in March, it brought with it shutdowns and business halts across the globe.
Building sites closed overnight and labor teams disbanded as developers sought to understand how long they might be facing closures. It also brought back painful memories from the 2008 financial crisis which saw construction sites across the U.S. permanently grind to a halt as customers pulled out of deals, banks ran out of liquidity and ultimately, developers ran out of money.
However, for the construction industry, the pandemic has so far been different. Just four months after many construction sites across the country were closed overnight (in many cases), they are not only up and running again, but business is booming.
It’s fair to say that we have seen a 180-degree shift between March and now. In fact, according to Trading Economics, national construction figures in June show a 13.8% month-on-month rise in the sale of new single-family homes, meaning a seasonally adjusted rate of 776, 000 new-home sales—76,000 units higher than the market expectation—as well as the highest level of new-home sales since July 2007.
For developers, this is not the only good news in the face of the COVID-19 pandemic. As opposed to the time during and after the 2008 financial crisis when liquidity and lending were painfully low, affordable borrowing for developers is as dynamic as ever. This is in large part due to the historically low interest rates we are witnessing in the face of the pandemic, and translates into both low-rate developer loans being offered alongside low-interest rate mortgages for house buyers.
This means builders can borrow more money to start more projects because the money is effectively cheaper to borrow, and enables them to earn higher margins while the pandemic-influenced interest rates remain so low.
Developers will need to be mindful of changes in customer behavior that will come from current and future pandemic-influenced events.
It’s also important to consider the impact of the COVID-19 pandemic on supply costs, and how this has made borrowing more affordable for developers. Lumber, for example, has seen significant swings in pricing since the pandemic began. According to the National Association of Home Builders (NAHB), while lumber prices were at a two-year high in July, in late February to early April they were almost 50% lower than this.
NAHB cites a number of reasons for this shift in pricing, including mills being closed due to the stay-at-home orders and social distancing measures, as well as a decrease in capacity utilization based on a projection that housing would experience a significant drop in demand.
For those developers who were able to buy lumber during the February-to-April period in anticipation of construction taking place over the ensuing months, they are now reaping the cheap lumber costs and benefits of loans going further when it comes to supplies. For these players, their borrowing became more affordable by virtue of their outgoings having been lower and them having to put less money into the same projects.
Banks Want to Lend
In comparison to the time during and after the 2008 financial crisis, banks have money to lend and they want to lend it. But with many businesses downsizing, streamlining or folding, financial institutions have a much more limited pool of potential borrowers to market and lend money to. The booming construction industry is an attractive proposition for banks to fulfill loans with.
While the onset of the pandemic caused increased restrictions for developers seeking loans early in the shutdowns, the changing nature of the housing market will have seen those restrictions lessened. Developers looking to borrow for construction at the beginning of the pandemic likely faced higher demands from lending institutions in regards to equity requirements or terms. Banks were likely seeking more money from the developer and less from the lender. Now, the low interest rates and rise in construction mean this has likely reversed and banks are offering favorable conditions on developer loans.
The construction industry has been able to benefit from the financial impact of the situation and take advantage of the affordable nature of borrowing, for now.
The uncertainty of the pandemic’s future means that while borrowing is currently extremely affordable for developers, in the event we begin to move backwards in the battle against the virus, we may well start to see borrowing for developers become restrictive once again, with a return to the state of the market at the beginning of the pandemic.