A Closer Look at Alternative Financing Options for Real Estate Development
The market dynamics within lending are complex, and even more so in our current economic climate. The unique challenges presented to the world recently have had a substantial impact on commercial real estate portfolios in the United States, including those composed of office, retail, hotel, restaurant and multi-family developments. There are significant challenges for borrowers and lenders who have relied on these market segments for years. On the positive side, these same market forces have created an unprecedented opportunity in the residential housing market, making it a sector that deserves a closer look.
The National Association of Home Builders (NAHB) saw builder confidence in the single-family 55+ housing market reach an all-time high in the third quarter of 2020, yet 55+ home buyers in the U.S. continue to be tremendously underserved. The demand for housing still far outpaces supply. New research by Zillow shows that buyers are bidding on a record-small number of homes for sale, with total for-sale inventory 37.4 percent lower in October 2020 than the year prior. The coronavirus pandemic has only further motivated Americans to crave well-designed homes and seek new living situations. There is a clear market need for housing and as a result financing can be easier to come by to pursue projects in this area.
More players are entering the 55+ homebuilding market to take advantage of the opportunity for a slice of the pie. The first challenge for many of these builders, especially if they are new to the industry or smaller in size, is securing the capital needed to acquire land and start a project. This is where the waters can get murky, but it’s time to take the mystery out of project financing.
Home builders and developers typically need to secure at least 20 percent of the overall cost of a project prior to its start. For example, the initial investment for a production builder can exceed $1 million. Project funding often comes from multiple sources including real estate development loans via local banks and/or project investors.
Acquisition and Development Loans
Acquisition and development loans (also known as A&D loans) are one of the most common types of land development financing options. These loans allow for the purchase of raw land that is ready to be developed, or for soft costs such as staffing and property improvements on already developed lots. Lenders today are bullish on the housing market for a number of reasons and there is a desire for banks to add A&D loans to their portfolios:
- High (and pent-up) buyer demand
- A longstanding shortage of homes
- Record-low mortgage interest rates
- A shorter sales cycle on homes
- Rising home prices in nearly every corner of the U.S.
A&D loans need to be supplemented with a vertical construction line of credit (LOC) in order to finance the actual construction of the houses. If you pre-sell some of your homes, acquiring this part of the financing is less complicated and banks enjoy the security of a firm contract and a down payment.
Private Placement Memorandum
Wells Fargo found that 77 percent of small business owners have to use their personal savings to start their business. Therefore, many home builders strategize creative ways to acquire capital in the early stages of a new project, such as through an equity raise. The use of a private placement memorandum is a great way for builders to provide a compelling investment opportunity, without divesting their ownership interest. Much like banks, many investors are looking for less traditional ways to earn great returns in these challenging times.
Obtaining financing can be difficult for businesses that do not have a proven track record, but working with a franchise can help. When you join a franchise, you are taking a calculated risk. This is attractive to both lenders and investors, who would be making a riskier investment by playing the market on a brand-new venture.
Now is a good time to research options for entering or scaling your business in the homebuilding market. With a strong demand for housing and low inventory, more home builders are needed to complete new projects and those building entire communities are all the more attractive.
Jad Buckman is business development director for Epcon Franchising. Epcon Franchise Builders are given exclusive access to the homebuilding business blueprint that has helped Epcon become a top 50 builder year after year. For more information, visit EpconFranchising.com.