Ashton Woods Homes’ CFO Cory Boydston has never been able to get private equity financing to work for this Roswell, Ga.–based builder. “The return hurdles are still too high, even at 25 percent,” says Boydston, “so there just wouldn’t be enough profit in those deals for us.” And unlike some builders, Boydston “can’t in good conscience” assume appreciation in a project simply to justify the cost of borrowing this way.

But despite its higher costs and prohibitive terms, private equity has been where some builders have had to turn when banks wouldn’t lend even at gunpoint. Private equity continues to hunt for the right opportunities: In July alone, three institutional investors paid $955 million to acquire Taylor Morrison, while SunBridge Capital Management entered into a multiyear agreement to help fund Comstock Homebuilding Cos.’ growth. Last September found Doug Bauer, CEO of Newport Beach, Calif.–based TRI Pointe Homes, gushing about his company’s alliance with Starwood Capital Group, whose $150 million commitment to the builder “provides us with a capital structure and transaction pipeline to take advantage of local and regional market opportunities.”

But given the overwhelming financial turmoil that has beset the country’s commercial and community banks, it’s surprising how relatively few deals with builders there have been where private equity has been a major contributor. And the window of opportunity within the housing sector may be narrowing for institutional investors, especially now, as banks are a bit more receptive to at least making construction loans.

Rarely an Ideal Fit

What’s become clear during the recession is that institutional equity was never a perfect fit for builders to begin with, even a company such as Centerline Homes in Florida that has always relied on some form of private equity financing. “You can’t get 30 percent IRRs in real estate; it’s not possible,” says Craig Perry, Centerline’s CEO, referring to investors’ lofty return-on-lending targets of only a few years ago. “Our costs have to be relative to the marketplace and to what allows you to make money on your product.”

Those rates of return may have come down, but institutional investors are still attracted primarily to real estate deals in which lots of money (at least $50 million) can be invested, and where investors can make money and be in and out of deals in three years. Those parameters simply exclude most small or midsize builders, especially those that are now building smaller communities to match modest buyer demand.

“It’s not a panacea, and it does not make sense for everyone,” says Jamie Pirrello, who after joining San Antonio–based Michael Sivage Homes as CFO in 2006 spent a year evaluating private equity financing. Now, as then, the big problem with private equity, Pirrello explains, is how deals get structured. “As a builder, you’re last in line to be paid.” And when there’s a profit split on the sale of land or homes, it’s often on a “waterfall” basis, where the investors get paid a certain percentage first. “If you don’t underwrite these deals cautiously, you end up working for the private equity firm,” says Pirrello.

Even Eric Lipar of LGI Homes in Texas thinks private equity “is playing out” as a financing source. And that’s coming from a CEO of one of the handful of builders that has employed private equity successfully and profitably to build and expand. “It’s a small box they fit into in the home building world.”

But Lipar acknowledges his company’s partnership with GTIS Partners, which is committing up to $50 million to the builder, has been essential to LGI’s growth. Through August, LGI had used $12 million to close on four transactions, through which it’s been purchasing finished lots in Texas and Arizona. Lipar has no problem with GTIS’s internal rate of return terms (which are in the 20 percent to 25 percent range), because “we’re making 50 percent” on the 10 percent to 20 percent of the total equity LGI is putting into each deal.

Private equity pencils out for LGI because of the sales volume it’s generating: The builder averages six closings per month per community (it closed 84 homes in August, a new monthly record), and its construction cycle is only 45 days per house. “If we were closing 30 percent fewer homes, we wouldn’t be making any money,” Lipar concedes.

Learn more about markets featured in this article: Atlanta, GA, San Antonio, TX, Los Angeles, CA.