As Austin, Houston, San Antonio and Dallas continue to infill, more borrowers are seeking funds not for rehab projects but new construction. Historically, hard money lenders and investors have largely stayed away from these projects instead focusing on funding rehabs. This has been due to many factors including perceived extra risk of a completely new development, the inability to liquidate the project property midstream, and incomplete knowledge of local regulations and market forces. At Little City Investments we do lend on new construction and believe it’s safe to invest in new construction. Here’s why:
The risk of investing in new construction isn’t materially greater than investing in a to-the-studs remodel.
A lot of times it makes sense to wipe the slate clean and just start over. As a builder, you may do a little more work, but often the cost is actually less to build new than to try and salvage an old house in poor condition. Since it’s often easier to get funding for a rehab versus a new build, borrowers often get themselves into trouble trying to remodel and add on to tear-downs. Often the scope of the demo creeps so much that all that ends up being left is some framing, and an old cracked slab with broken plumbing underneath. This is a bad situation for the borrower and the investor.
We want to see the highest and best use of a property realized because that is the best scenario for everyone involved. As experienced developers ourselves, we can accurately judge what needs to be built (or not) in order for everyone to win. In many ways there’s less risk with new construction than with a remodel/addition: There are no wild cards with plumbing, electrical, foundation, etc. The final product can be more consistent with new comps in the area, reducing resale uncertainty. And more times than not, you just get a better, more valuable end product.
If the loan goes south during construction, we can handle it.
This is really the greatest risk of investing in a construction project: a borrower default in the middle of the process. We vet the construction project extensively prior to funding. We review design, sales comps and borrower experience. We think, is this a project we would do ourselves? And the answer has to be “yes” if we decide to move forward. But crazy things can happen and for whatever reason, even experienced builders can default during a project.
*Full disclosure: At LCI, we’ve never had a construction project fail mid-stream, but we’ve seen it happen and understand that there must always be a contingency plan.
That’s why we will never be out over 70% of the value of the project at any given time. And that 70% LTV is based on liquidation value, not necessarily optimized market value. Which means that if we have to foreclose, we can be confident that the property would sell at auction for at least the loan amount. If it doesn’t then, it most likely will sell on the open market in less than 30 days since it would be priced at liquidation value.
But even if it doesn’t sell at auction or on the open market, and we have to take the property back, we can still handle it. Really, taking control of a construction project is better than taking back a rehab. Unlike many rehabs, with new construction, there are architects, engineers, detailed plans and even general contractors attached. The change in ownership doesn’t have to affect the completion of the project. And once complete, the property can be properly sold on the open market for full, optimized market value, not only paying off the loan, but also yielding at least an extra 30%.
Of course taking back the property is always extremely unlikely since we’re consistently conservative with our project choices and valuations.
The market demands new construction.
The demand for hard money construction loans in Texas is extremely high at the moment. In fact over half of all the leads we get are for new construction. Why is this?
- The economics for new construction make more sense in desirable central city locations. In Houston and San Antonio, building costs remain relatively low and older residential properties are usually not worth saving. Couple this with little to no zoning limitations and the square footage calculation alone tips the scale to new construction. While Austin is more regulated, a steady stream of people continue to move there, consistently fueling new housing demand.
- In-fill deregulation allows for more profit. In Austin new allowances have been made for construction of 1100-SF auxiliary dwelling units on single-family properties. These can then be separated through a condo regime and sold independently from the main unit. This single deregulation has caused demand for construction loans in Central Austin to skyrocket.
- New construction helps cities reach their density goals. Certainly there’s an argument to be made that too much new construction adversely affects the character of a neighborhood, but cities need the infill to be able to grow efficiently, control sprawl and maintain a healthy tax base. Generally, when the city’s and developers’ interests are aligned, it’s a good sign for real estate investors. This is largely the case in Texas.
Based on these considerations, we don’t see a logical reason to stay away from construction loans in Texas. Certainly there are many factors at play, but through knowledge of local markets, intense project vetting and strong contingency planning, we can mitigate risk to acceptable levels and fund successful new construction projects in Austin, Houston, San Antonio and Dallas.
Interested in investing in new construction projects in Texas? Contact us now to get started.