Brother, I can spare a dime: Construction lenders open wallets, but only to known developers

With the Great Recession winding down, New York residential developer Alchemy Properties was gearing up to start construction on a planned condo conversion at 35 West 15th Street, now known as 35XV. But Alchemy President Kenneth Horn wasn’t sure if he’d be able to get a construction loan, since the recession had virtually halted financing for new condos in New York.

Fortunately, Horn connected quickly with M&T Bank and Capital One, lenders he’d used for years before the recession. In 2010, he secured construction financing of roughly $70 million.

Three years later, units at 35XV are on the market asking $2 million to $12.6 million. And banks’ purse strings have loosened up even more when it comes to new condos — at least for experienced developers like Horn — thanks to rising land values and a stronger real estate market.

For the past few years, most of the new projects hitting the market in New York City have been rentals. But established developers told The Real Deal that they are now finding a flusher climate for condo construction loans, with M&T Bank, Capital One, Citibank, Wells Fargo and Bank of America among the most active lenders. That’s due largely to the health of the condo market, but also to the fact that returns for banks remain generally higher for condo-construction loans than for other types of lending.

“There is a much more stable and secure market today,” said Barry LePatner, founding principal of LePatner & Associates, which represents developers in construction projects. “Lenders are, of course, being cautious. But they also want to get that higher interest rate they know they will get on a construction loan.”

Still, even longtime developers have to put in more equity than they did during the mid-2000s real estate boom. And newcomers to the market still have a hard time getting financing.

“Construction lenders — [the ones] we deal with at least — are still only lending to people who’ve done it before,” Horn said. “They have not reached the point where they are lending to people who are novices. The pendulum hasn’t swung that quickly, to where your first-time developer is able to go out and get a construction loan.”

A stronger market

For the last few years, condo projects were seen by lenders as risky bets because of consumers’ difficulty in securing mortgages and a glut of unsold inventory in some areas of the city. If lenders were financing for any residential construction, it was for rentals, which shot up in demand due to the slumping for-sale market.

“If you had asked someone about a condo loan a few years ago, they would have laughed at you — it was pretty much nonexistent,” said Andrew Gerringer, managing director for new business development at the Marketing Directors.

Several large projects originally planned as condos, such as the Frank Gehry–designed 8 Spruce Street and 864-unit Mercedes House, hit the market as rentals instead. Other condo projects stalled or changed owners.

But with the economy now on the mend, the inventory of available New York City condo units has shrunk while buyer demand has grown. The available inventory of Manhattan condos for sale was down 35.4 percent annually in the first quarter of 2013, one of its biggest drops ever, according to Miller Samuel Real Estate Appraisers.

As a result of these factors, the condo market has rebounded: The average sales price for a Manhattan condo spiked 13.8 percent to $1.2 million in the first quarter of 2013, according to Miller Samuel.

Now, in an encouraging sign for lenders, new product “gets absorbed rather rapidly, because there’s no inventory in the city,” Gerringer said.

And construction loans, including those for condos, have traditionally provided higher rates of return for lenders than non-construction loans. Additionally, lenders distribute money as a condo project moves along, often month by month, further reducing their risk.

Another reason for the looser lending spigot is the price of developable land.

Many condo projects that failed during the recession were those that had been purchased for very high prices during the boom, making it harder for developers to lower sales prices once the market cratered. Others found they couldn’t get financing to start construction, with banks looking askance at the high prices they’d paid for the land.

“The projects that went under,” LePatner said, “were projects where the land had been purchased at excessively high rates compared to what happened after that, when the market dropped out.”

Land prices dropped by double-digit percentages during the recession, allowing investors to swoop in and buy development sites for discounts of up to 30 percent, LePatner said. Since then, land prices have increased dramatically. Data from the brokerage Massey Knakal shows Manhattan land prices increasing 25 to 30 percent in the first three months of 2013 from the prior quarter.

The rising price of dirt, coupled with a stronger condo market, make it much more likely that developers will pay back their loans rather than default. If they do default, sources explained, banks are content to take back land if they know they can sell it for a high price.

For developers, the high cost of land is now making it more difficult to do rental projects. Development costs in Manhattan are now around $300 to $400 per square foot, while the average price per square foot for a Manhattan condo was just over $1,300 at the end of 2012, one of the highest averages since Miller Samuel started keeping records in 1989 (and only slightly below the peaks reached in 2008). By contrast, a new-construction apartment tower would likely rent for no more than $75 per square foot.

“The reality today is the cost of land is now pushing, in the boroughs and in Manhattan, to the point where it’s very hard to pencil out doing a rental,” Gerringer said. “You’re either going to be forced to do a condo building, or the sellers are going to be sitting on their land because buyers can’t afford to pay the price.”

Skin in the game

Still, today’s environment is far from the easy-lending days of the mid-2000s.

While the terms of condo-construction loans remain largely unchanged from before the recession — interest rates, for instance, still range from 3 to 5 percent — even experienced builders are now expected to put more equity into their projects than in the past. During the boom, condo developers generally had to put up 25 to 30 percent of a building’s projected cost in equity or personal guarantees to get a construction loan. Now, developers are generally expected to put in 30 to 40 percent.

“The biggest difference [today] is how high they will take you,” Horn said of lenders. “So, if your aggregate costs were $100 million in the past, certain lenders would have taken you up to $72, $73, $74 million — and now maybe they’ll only go between $55 and $70.”

One thing working in developers’ favor is cheap borrowing costs, though interest rates are starting to creep up.

“I think anybody who has the ability to lock down long-term rates, if they have a stabilized property, they’re doing it now, for the most part, across the system,” said Peter D’Arcy, regional president for M&T Bank in New York City.

While more deals and higher prices have elicited some warnings of a bubble, sources noted that demand still far outstrips the available supply.

Much of the new condo development recently has been ultra-luxury, such as Extell Development’s One57 — financed by a syndicate of lenders led by Bank of America — where units have sold for eight figures. And at new condo 56 Leonard Street, which was financed by M&T and Bank of America, units have sold for north of $4 million and up.

Other projects are smaller-scale, like Alchemy’s 55-unit 35XV. With a few exceptions, gone are the pre-bust days of big projects like the 580-unit Sheffield conversion or the redevelopment of 20 Pine Street, which produced 408 condos. These smaller projects perpetuate the low inventory that helps spur the construction financing in the first place.

“When projects come on, it’s not 300 units; it’s 50 units or 100 units,” Horn of Alchemy said. “So even though you might have 15 projects coming on, it’s only adding maybe 700 units to the marketplace.”

Or as LePatner put it: “There is a really great sense of confidence that there’s not going to be any overbuilding.”

Correction: A previously published version of this story misstated the prices at new condo project 35XV.  Prices in the building in fact range from $2 to $12.6 million.