There is plenty of capital out there to do deals. We just moderated a very diverse panel who has invested more than $1.5 billion in home building and land in the last year. We also discussed these topics:
- Construction Debt: Recourse and non-recourse debt is available, and priced according to risk. Bank of America has been very active and is looking at funding a large number of construction loans right now, in a wide variety of formats, and Presidio Residential committed $125 million last year and plans to commit another $45 million this month. Pricing varies on the situation, but is generally from:
- A 1% fee and below 5.5% interest rates for the most conservative recourse loans to companies with a minimum net worth of $10 million, to
- A 3% fee, 12.5% interest rate and 3% of the home sale for the riskiest loans (75% loan-to-cost on a non-recourse loan to someone with little net worth in a tough market).
- Project Equity: GTIS has funded $220 million of unlevered equity in U.S. home building in the last 18 months, Mountain R.E. Capital funded $200 million in 15 deals last year, and Oaktree has funded or committed to fund over $1 billion into the residential sector over the past 24 months, including investments in land, bank loan portfolios, and individual homebuilders, including Taylor Morrison/Monarch Homes. Project equity is looking for the locations with predictable absorption (A and B locations), but is buying the C, D and F locations as part of bank portfolios who are forcing them to take the good with the bad. The C, D and F locations are not coming to market individually because little money can be made and the FDIC portfolio structure encourages them to hold those assets for a while. Equity wants a 20%+ unlevered return, which makes it hard to find deals. In fact, most agreed that public builders were buying land at much lower returns, which makes finding deals very difficult.
- Location: California, Texas, Colorado, Seattle, DC, the Carolinas and Nashville were all mentioned as underwritable markets today, with the struggle being to find enough good parcels.
We asked the participants how they would address investing in three types of privately owned companies with a variety of backgrounds:
- Newco: Newly formed team with plenty of experience
- Great Track Record: Experienced team who took their lumps in the cycle but whose previous lenders / partners want to continue to do business with them
- Questionable Track Record: Same as above but their previous lenders / partners refuse to do deals with them because of their execution skills or other problems during the downturn
We learned that all three groups can get debt and equity financing. Clearly, the third group will need to put up more of their own capital (friends and family capital is ok for some groups but not for others) and their new capital will be more expensive. We also learned that:
- Big Bucks are Better: Debt and equity groups want to do a lot of business with you, so they prefer groups that they can learn to work with who will bring them many deals over the next few years. For the same reason, large deals are better than small deals.
- Restructuring: Legacy problems can be recapitalized, especially since the debt and equity groups know that you know the land far better than you know any new land you might purchase. The more expensive capital providers won’t blackball you because of a few bad deals in your past. They want to understand the full story and will talk to your past partners.
- Fantastic Market Knowledge and Conservative Assumptions: Most capital providers assume flat home pricing and absorption, although they will assume increasing absorption when appropriate. The builder/developer must have very in-depth market knowledge to get financing. Everything that can be known before funding the deal should be known, as there is little room for mistake in this market. A reliable and independent second opinion on the assumptions is very important, and needs to include far more than the traditional competitive pricing graph. Because of this, deals are taking longer to consummate that historically.
- Deal Flow is Picking Up: While all mentioned the dearth of investment opportunities, all of the participants have seen more good deals in the last 90 days than they have seen previously, and they expect deal flow to continue to grow this year. The group noted that more banks, particularly the larger banks, seem to be coming to market with distressed assets.
- Capital Pricing Pressure: The banks and equity providers are seeing more competition, which is pushing their required returns down. However, they also have more clarity into the future than before, which is giving them comfort.
For startup companies without much of a track record, the panelists recommended staying small and focused to build a phenomenal track record, using equity from friends and family and debt from your local community bank.
The one hour long webinar can be found here. You will need to register, but it’s free.