By William Procida, president, Procida Funding & Advisors
I’m driving down the highway in a Ferrari and I just got passed by a minivan doing 100 mph. In the minivan’s driver’s seat was a local banker, in the passenger seat, the Federal Reserve, and in the back, eating Happy Meals and playing with video games, is the American tax payer completely unaware they just blew past me. In my rear view mirror, there’s another minivan trying to pass me.
Yes, it’s happening again. I can’t believe it. Banks are now offering land acquisition financing of 85 % and 100% of construction costs to housing developer’s .Yes, the very lending practices that caused the excessive over building that caused the recession are now alive and well. What’s most amazing is how fast it all happened.
Just six months ago I wrote a piece entitled, “Things Are Just Fine. Now Let’s Not Screw It Up.” That was because six months ago, things felt fine. I was cautioning the market against too much loosening of credit and aggressiveness lending. While liquidity was not rampant in the first half of the year, there was enough to reboot the market. There certainly wasn’t any land money being lent by banks.
Up till now most of the unpredictable stuff, like distressed debt, half builts , restructurings and value-add, was handled by guys like me running private equity funds with intensive and true “hands on” approaches. The private equity market was then being complemented by the banks who took us out when the asset was stabilized. That is how it’s supposed to work.
What’s most interesting is banks are supposed to be more conservative than private equity and now the banks, especially the ones doing 85% land acquisition financing, are lending more aggressively than private lenders and at lower rates! Let’s remember that most of what they are lending is borrowed from the Federal Reserve (i.e., you and me—the American taxpayer).
At a recent dinner with the CEO of one of the country’s top and most disciplined community banks, I listened as he lamented about how his competitors stealing market share by simply being undisciplined. Lending too much and at too low of a rate to people who probably don’t warrant such aggressive loans. When I asked about Dodd- Frank and all the new regulations, he simply stated, “There is always a way that guys in banking maneuver around regulations.”
Just as I suspected.
The good news is housing starts are still low, running at half of the last five years vs. the peak of 2005. So it will take at least three or four years before we have to worry. As I wrote in a 2006 article, “The Coming of the Half-Built” when the market was peaking, I warned banks to slow their construction lending. But they never do until it crashes and then they just walk away. In early 2007, I wrote a piece, “Revenge of the Asset Manager,” suggesting that banks turn all their originators into asset managers; slow lending, and concentrate on batting down the hatches. Of course they didn’t listen; the cycle always repeats itself so you will likely see me reprint the identical articles in three to five years.
What is always so remarkable to me is how short memories are in the finance business. You would have thought after the Savings & Loans Crisis in the late 80’s that the regulators and government would have been able to avoid “The Wall Street–subprime CMBS—Too Big to Fail Crisis.”
Hopefully, this lending by aggressive local and community banks will be kept in check. There have been a number of articles already using the word “bubble” in the housing market. I cautioned two years ago at a housing conference that I feared a mult family rental housing bubble would be caused by banks chasing that asset class and beating each other’s brains out with higher loan amounts at lower pricing. Now they realize that there are too many lenders chasing the same deal; so……..
Now that approach is being taken towards development. It happens subtly when the board of directors of a bank says, “We need to increase earnings” and the originators say, “Sure let me be more aggressive than everyone else.” Then the next bank does the same and so on.
Like I said, we have at least four years before the next crash and the liquidity will help the market and the overall economy because as housing goes so goes the U.S. economy. With all the wars and terrorism going on throughout the world, the U.S. will continue to be the safe harbor for investment and expect immigration to help the market cause if you live anywhere over there you definitely want to be here … good for housing .
While liquidity is critical to the economy and real estate values, too much of a good thing as we know, causes a bad hangover. Be careful. Don’t drink too much. To my developer friends; just remember this: just because they want to throw money at you, you may not always want to take it. Remember, loans are just preferred equity. When the you know what hits the fan, you’re the first to get thrown out off the boat even though the next guy may make a fortune on a simple timing/liquidity evaporation play, even though you did all the heavy lifting. Stay liquid my friends!