Tom Hoyt just wanted to moveforward. Having liquidated his old company, McStain Enterprises, in the spring, he planned to start over again as a green developer and builder. But where would the money come from initially? “It’s clear to me that if you need to get anything done in the next few years, you’ll have to go to private” financing, says Hoyt. So he joined forces with an infill developer, International Risk Group, and a private equity partner—whom he describes only as a high–net-worth individual—to form Denver-based MC3 Holdings, which operates as McStain Neighborhood Builders. That equity source provided the capital Hoyt needed to “rejigger” an existing $2 million bank loan and secure another $2 million for construction.
Banks will still work with builders that come to the table with such “sponsors,” says Hoyt and several other sources contacted for this article. And being attached to a private investor can be a deal maker, as LGI Homes has discovered since it entered into an alliance with GTIS Partners this spring to spend $50 million to acquire homesites. In July, LGI used some of that money to close on 100 acres in San Antonio’s Luckey Ranch, with the option to buy 400 more. That deal puts 2,200 lots under LGI’s control, says CEO Eric Lipar.
Lipar is quick to note that firms such as GTIS wouldn’t give him the time of day if LGI Homes wasn’t profitable. And the number of these firms probing the housing sector for opportunities is probably less than what most builders perceive. Rob Vahradian, GTIS’s senior managing partner, thinks there might be only a half-dozen national private equity firms actively vying for the same space as his company. Reuben Leibowitz, whose JEN Partners helped bankroll Joseph Carl Homes and Sun Terra Communities, says that while there are plenty of people bidding on deals, far fewer ever get to closing because they haven’t the money nor the stomach for the risk.
Builders or developers don’t need reminding that financing for land acquisition, development, or construction is pretty scarce right now. Just ask the 20 or so builders who were listening in on a Shinn Group–moderated webinar about that very topic in July. Sixty percent of them said they’ve had no luck securing financing of any kind during the housing downturn. Among those who have, more than two-fifths are tapping friends and family.
The recession has hamstrung banks to the point where federal regulators seem to treat housing-related lending like it’s a terrorist threat. But it stands to reason that banks will be players in this industry again. Dave Ledford, NAHB’s staff vice president for housing finance and policy, even thinks they’ll come back in a major way. What he and everyone else can’t predict is when. It could be two years, or longer, before banks lend to builders with any regularity. Meanwhile, more builders are weighing the pros and cons of drawing upon private investors or funds for capital and debt.
Using money from private sources has drawbacks. For one thing, it can cost one-third to one-half more than bank financing, estimates David Weekley, chairman of Houston-based David Weekley Homes, which with Midway Cos. successfully raised $25 million—mostly from individuals—to acquire approximately 700 to 1,000 homesites. Equity firms, he adds, expect a 25 percent return on their investment, “and it’s hard for builders to generate that on a day-in, day-out basis.” A debt provider such as Newport Beach, Calif.–based Sentinel Capital charges 12 percent to 15 percent interest and expects builders to contribute between 20 percent and 25 percent of any project’s cost, compared to the 10 percent banks typically require, says Bruce Beck, Sentinel’s president.