We have been getting a fair amount of new loan inquiries from developers lately. They are hearing that interest rates are at historical lows and want to look into securing a construction loan for a new project. While low interest rates may be the case for new home buyers or those wanting to refinance a mortgage, however, the exact opposite is true for commercial development projects. Because the capital markets were frozen for quite a while, rates for these types of loans have gone up and leverage levels have gone down. We are seeing current rates up about 200 basis points (ranging between 10 percent and 12 percent) from pre-COVID-19 rates.
Lenders—especially banks—are being extremely cautious about where they place money as they aim to preserve their cash reserves. If they are to move forward on a loan, it will be at a higher interest rate than prior to COVID-19 to mitigate the higher risk. If a lender is going to move forward on a deal, it has to make sense on all levels. So, while in February lenders were looking to put money out, now it is just the opposite. As a private construction lender, while we are being conservative on the projects we underwrite, we are able to have more flexibility on what we think makes sense in today’s economic environment.
From a developer standpoint, while they are still actively looking for opportunities and are generally optimistic, what they were willing to pay for a development project in February 2020 is not what they will pay now. Borrowers that were in escrow on a deal that wasn’t locked in prior to the crisis, have worked to either get a discounted price or canceled it altogether. The thinking here is that if there is more distress in six to 12 months, it would be prudent to hold off and acquire a parcel at a discounted price a little further down the road.
Looking forward, the good news for developers is that they will likely be able to access better deals on land pricing over the next 12 to 18 months. Additionally, we believe that construction costs will be coming down as development slows and the cost of labor and material drops.
I think that at a certain point, construction financing rates will trend downward once lenders feel more confident and seek to infuse the market with capital again. Right now, however, the industry is in a “wait and see” mode, especially because no one can predict if there will be a second wave of the virus later this year, and what it would look like.
Only time will tell when and how we will emerge from this devastating global event, however, the demand and need for new development remains, and when the dust has cleared, developers may be in a better financial position than before the COVID-19 crisis, when land pricing and construction costs were at all-time highs in many markets.
By Paul Rahimian, Founder and CEO at Parkview Financial
Commercial Property Executive