Peter Pays Paul

Calculated Risk’s post More CRE Woes: Multifamily housing details that loans on multifamily properties have seen an increase in delinquencies.

Apartment to Condominium Conversions

Some of this can be attributed to the reconversion of condominium conversion projects.

During the heyday of low interest rates and the housing bubble. Developers were buying apartment buildings, upgrading the units, filing a condominium map, and then selling the complex as condominiums to buyers. Often this was less expensive than buying land and building a brand new condominium project.

Condominium to Apartment Conversions

With lending criteria tightened, demand for condominiums has dramatically fallen.

Developers are being forced to offer these projects not for sale but for rent in order to make loan payments on their construction loans. These condominiums are being returned to rental status.

Rental Supply and Demand

Initially the condominium conversion projects decreased the available supply of rental housing, as apartment projects were bought for conversion. A decrease in supply lead to increasing rental rates.

Today, the opposite is happening. Condominium projects that are rented are increasing the supply of rental units and rental rates should decrease.

Calculated Risk’s post from Friday, The Residential Real Estate Market, details this exact scenario.

Adding to the woes are the fact that thousands of vacant single family residences are still on the market. As these are absorbed demand for rentals is likely to decrease again pushing rental rates even lower.

Part of my job is to take incoming cold calls. We advertise in a commercial lending industry magazine that generates a good deal of call traffic.

On a regular basis I get requests for “construction” loans. After asking some questions to determine the nature of the loan, I usually find out that the broker/borrower is actually searching for what I would call a “development” loan.

What’s the Difference, Who Cares?

Why does it matter if you call it a construction loan rather than a development loan?

First, it reflects on the broker/borrower. If a lender has to educate the person requesting money, it sets a bad tone for the deal.

Second, some lenders offer construction financing but don’t offer development financing. Asking the right question allows you to get a correct response and save you time.

Finally, loan to value and equity requirements may vary depending on whether the loan is for development or for construction; I know ours do. This information helps the lender determine if the loan is within their parameters.

Construction vs. Development

Construction by definition has the connotation of putting things together. In my mind, moving dirt for roads or infrastructure does not meet this definition (no offense to those in the fields of civil construction).

The definition of the word develop includes the idea of being made usable. This is perfectly suited for the installation of roads, pads, and infrastructure; as the land has now been made usable for a building.

Defining Loans

Consequently, I would recommend that if you are asking lenders for a construction loan, a building should be in place when construction is complete.

Loans to improve land should be titled as development loans.