With demand for new commercial buildings and interest rates holding steady, it’s a prime time for developers and construction companies to obtain the financing they need to take projects from the drawing board to reality.
Banks have been easing lending terms for commercial real estate loans during the past year, according to the April 2018 Senior Loan Officer Opinion Survey on Bank Lending Practices. The quarterly survey of 72 large domestic banks and 22 U.S. branches and agencies of foreign banks is conducted by the Federal Reserve System. In the survey, banks cited “more aggressive competition from other banks or nonbank lenders as an important reason for easing.”
“It’s very competitive,” says David Weed, assistant vice president of business services at Service Credit Union in Portsmouth. “A smart borrower will ask two or three institutions to bid on a project.” While Service Credit Union has funded construction projects up to $35 million, most of its commercial construction lending is for projects in the $10 million to $20 million range, Weed says, noting there is not as much competition for funding projects that size as there is for projects that are in the $5 million range.
The Federal Reserve System report notes the results are notable as this was the “first quarter in almost three years in which banks, on net, reported easing standards.” Other reasons banks gave for easing lending standards for commercial real estate loans are: increased tolerance for risk and more favorable or less uncertain outlooks for property prices and vacancy rates.
The banking community was split over demand for commercial real estate loans with the number of banks experiencing stronger demand over 2017 only slightly outpacing the number of banks facing weaker demand. Banks experiencing stronger demand for commercial real estate loans cited increases in customers’ acquisition or development of properties and “a more favorable or less uncertain outlook for rental demand,” according to the report. Most banks facing weaker demand blamed “decreases in customers’ acquisition or development of properties, rising interest rates, and shifts of customer borrowing to other bank or nonbank sources.”
Indeed, historically low interest rates that helped to spur lending began creeping up in the last three to six months, says Michael Arndt, vice president of commercial lending and market manager at Kennebunk Savings in Portsmouth. However, “the market is still very vibrant, and there is a lot of capital available for developers who have the relevant experience and the financial wherewithal,” Arndt says.
Joshua Reap, president of the Associated Builders and Contractors of NH and Vermont, which has 200 members, agrees that contractors and construction companies that already enjoy good working relationships with banks should continue to receive the funding they need.
A Strong Market
Paul Falvey, president of Bank of NH in Laconia, says bank officials are always analyzing the latest data from the Federal Reserve and other regulators to determine if the state is still in the midst of a building boom or if there are signs that it will slow down. In the Greater Boston market, rents are starting to abate and absorption is slowing down. But the building activity in NH is still steady and has not shown signs of slowing down yet.
The demand for residential buildings and office space is strong in southern NH, he says, adding the Greater Boston market continues to sprawl into southern NH, fueling demand.
“It’s been significant,” says David Weed, assistant vice president of business services at Service Credit Union in Portsmouth, of his institution’s commercial lending activity. “The last two years, we’ve seen an increased amount of activity. We’ve seen a doubling of construction requests during that time frame.”
Weed says the bank has a significant pipeline of construction projects under consideration for funding. “We’re still in a strong economy. There’s still a lot of consumer spending. Businesses have stronger balance sheets to make these investments,” he says, adding while the economy may slow down in three to five years, the credit unions expects to see continued robust investment in the commercial building sector for the next two years.
Throughout the Seacoast region, Arndt says there are many projects that have been approved by municipalities like Portsmouth, Dover, Hampton and Rochester in the last five years, and they are seeing a lot of developers and construction companies seeking funding.
“We’re seeing a high volume of residential construction, mixed-use development, apartment complexes and townhomes in certain areas,” Arndt says. “Many developers have experience doing these types of projects, and some are less experienced, which does increase our required
Kennebunk Savings has branches in Portsmouth, Hampton, Dover, Stratham, Durham and Newmarket, and in these markets, there is a steady stream of requests for new construction funding. Entire city neighborhoods are being redeveloped with new mixed-use office and residential buildings and retail space. Arndt cites the West End and Islington Street sections of Portsmouth as examples.
There’s Still Standards
But just because there is a building boom and increased competition between banks doesn’t mean banks are handing out loans like candy. Banking institutions must still ensure they follow prudent underwriting guidelines. For example, Arndt says borrower equity and liquidity are important so that the developer has the ability to inject more cash into the project if needed. He says developers and construction companies must always do their homework so they can show a financial institution their project will generate the return that is needed.
The likelihood to meet sales and occupancy projections within stated timeframes is an important consideration during the loan approval process. “At Kennebunk Savings, we have been consistent in our approach to development projects regardless of demand and competitive pressures,” Arndt says.
Banks are careful with whom they do business, says Falvey of Bank of NH, which oversees 24 branches from the North Country to the Seacoast region. “By the very nature of it, construction money is the highest risk lending banks go into. There is risk related to the project itself and risk for the cash flow,” he says. “As a result, you have to go through all your appropriate levels of due diligence. You have to look at what is going on in the industry like rental rates, demand, number of new units coming on line and absorption rates for office and residential unit space being filled.”
Banks also have to do due diligence about the borrower. “It would be hard to consider a construction project from someone who is not a known and experienced borrower,” Falvey says.
“Have they done this type of project before? How realistic is the budget and the estimates involved?”
Falvey says if the party in question is an experienced developer and they have the right amount of equity to put into a project, they can secure funding. Out-of-state developers and construction companies can get funding if they can demonstrate a good history wherever they have done similar projects, he says. New players in the market could still secure funding, but they might have to put up more equity before enjoying more favorable terms as their history and experience improves, he adds.
“The projects we have typically underwritten are with seasoned businesses,” says Weed of Service Credit Union. “These are not startup organizations. We’re not seeing speculative construction. They have equity to support the project.”