The Housing Chronicles Blog: Construction Loans Souring Next?

Friday, December 7, 2007

Construction Loans Souring Next?

A story set to run in Saturday's New York Times tells us that we're moving towards Stage 2 of this housing downturn: construction loans in peril.

Says the article:

Figures compiled by the Federal Deposit Insurance Corporation and released last week show that both midsize and small banks had construction loans outstanding that were greater than their total capital. A decade ago, such loans were equal to only a third of capital for those banks.

For most of this decade, that was a good strategy. Construction loans proved to be very profitable, particularly for smaller banks as competition from larger banks and securities markets eroded their position in areas like mortgage lending and credit card issuance.

Now, however, more than 3 percent of all construction loans are classified as being nonperforming, or have borrowers that are behind on their payments. That is the highest proportion in a decade.

In the real estate market research game, this is fairly typical: first sales slow, and we don't have a lot to do because builders start to put plans for new projects on hold and it's mostly about working on mixed-use, infill or non-residential projects or helping residential builders get a sense of incentives, price reductions, and what works in today's market to move product. This is a good time for us to take a vacation and catch up on long-delayed visits to the doctor and dentist (I even got an orthodontist!).

Stage 2 is more about focusing on existing projects that are not performing well at the behest of investors, partners and lenders, but this is an important stage because it helps us set the new pricing models that will absorb inventory. Stage 2 is also when some land sellers who've been sitting on the sidelines (and watching the recent Lennar land sales) may have trouble holding on, depending of course when they bought their land, how much they paid and the extent of their resources to stay in the game.

I'd expect Stage 2 to start gaining momentum after the holidays, because given the slow torture of how Stage 1 has played out over the past 15-18 months, many would like to see the market take care of itself sooner rather than later.

How ironic would it be if the supply side of building homes (i.e., construction lending) took care of itself by letting the market make its own corrections vis-a-vis oversupply and soured loans while the demand side (i.e., mortgages) is delayed so politicians get *some* voters to believe that their fixes will actually help?

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