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Local and Regional Banks Double Down on Construction Lending for Apartments

Banks provided 71 percent of all construction financing in 2017, according to data from Real Capital Analytics.

Local and regional banks are making more loans on apartment properties, in some cases significantly more. In one surprising example, the busiest construction lender in the U.S. in 2017 was Bank of the Ozarks, according to Real Capital Analytics (RCA), a New York City-based research firm.

“A smaller bank, it has established itself in a niche to take on larger assignments,” says Mitchell Kiffe, co-head of national production for the debt and structured finance group at CBRE Capital Markets.

Banks are continuing to pour money into apartment projects, keeping the total number of units under construction high. The new developments will continue to stress the supply/demand balance in a growing number of apartment markets where vacancy rates are beginning to creep up and rent growth is slowing down.

Lots of loans by regional banks

Banks provided 71 percent of all construction financing in 2017, according to data from RCA. Regional and local banks continue to gain market share and had the largest market share last year—33 percent of the construction loans made in 2017. Smaller banks continue to make most of the multifamily construction loans under $30 million.

“Regional banks are still searching for yield in this flat yield curve environment… commercial real estate lending is an attractive alternative,” says Justin Bakst, director of capital markets with research firm the CoStar Group.

Top lenders include banks such as Salem Five, which is winning bigger deals in the Boston area, including 10 Shipyard Drive and Hingham Moorings South. Fulton Savings Bank also just financed a major project in Philadelphia.

The market share of the large national banks has been on the decline, falling from 45 percent in 2015 to 28 percent in 2017. “Larger banks have faced increased regulatory pressure from the likes of Dodd Frank and Basel 3,” says Bakst.

“Some of those larger banks may only have been using these regulations as a reason they could quote to their customers for not doing more construction deals so they could keep their exposure in those sectors that may concern them in check," says Thomas Wise, managing director of client services at Trimont Real Estate Advisors, a real estate asset management, due diligence and servicing firm.

For typical construction loans, from $20 to $60 million in size, banks now offer floating interest rates ranging from 275 to 325 basis points over LIBOR. “Occasionally we see a spread seems on the low side,” says Kiffe. “Maybe the market would be 25 basis points or more higher… Some of the little banks are not as deep into the market.”

Banks continue to prefer to make recourse loans, in which the bank has a claim on the borrower in case of a default. Non-recourse loans are also available, though they are often smaller in size, often covering 55 percent to 60 percent of the value of the property. “A lot of our clients continue to want non-recourse loans,” says Kiffe.

Fundamentals still strong

Banks are also highly conscious that developers are building more new apartments in some cities than the local markets can absorb. “Urban infill markets have seen a lot of supply,” says Kiffe. That’s beginning to push the vacancy rates higher in some places. “Net effective rents probably have not achieved the pro forma estimates set for many projects,” Kiffe notes.

The drop in construction starts has been slower to materialize than many expected. “There continues to be strong demand for rental housing,” says Kiffe.

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