Banks don’t fully know who will be able to execute at the onset of a project. The best they can do is to work with developers who have a long established track record. Even this is no guarantee of success. But it erects a fairly sizable barrier to entry for smaller, younger, or unproven outfits who don’t have any track record to speak of, to say nothing of a proven one. A catch-22 materializes. The only way to get financing from a bank is to have done projects before, but the only way to have done projects before is to have gotten support from a bank previously.
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These imperatives privilege a concentration of the most well-capitalized firms who have done the most projects before. In 2022, nearly 25% of all multifamily units started in the country (more than 132,000) were commenced by just 25 developers. That’s a strikingly high percentage in a country of more than 60,000 developers. Similar trends exist for new single-family homes. According to the National Association of Home Builders, in 1989 the ten largest builders “captured 8.7% of closings. By the year 2000, the share was 18.7%; and by 2018, 31.5%, reaching above 30% for the first time.” In 2022, that number reached 43.2%.
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At the turn of the millennium, institutional investors allocated just 2–3% of their portfolios towards real estate. Two decades later, target allocations have jumped north of 10%, a ~3–5x increase. This spike tracks eerily close to both the increase in private construction spending since the mid-90s, and the balance of outstanding multifamily loans originated in the last 25 years, which have increased from $288 billion to $1.37 trillion. The total market for professionally managed real estate now stands at $5.3 trillion in the US.
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Naturally, the biggest developers aren’t building duplexes, quadplexes, or rows of townhomes. They’re building projects that can absorb tens of millions of dollars—structures with hundreds of units. Those 5-over-1s you’ve seen popping up everywhere.
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Institutional developers rarely build in their backyards. They're based in a select few city centers (New York, Dallas, Chicago, DC, Miami, San Francisco), and are thus infrequently connected to the places they build in. This leads to a product with little personality—getting creative with design is a risk that might not pay off, after all.
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In reviewing many dozens of financial models and development schemes for small builders every year, I’m constantly surprised (and heartened) by how many of them care deeply about the quality of what they build. They defiantly underwrite rents lower than what they might be able to achieve because they don’t want to spurn the community that gave them so much. They often build strange and superfluous design features for no other reason than that they like them. They’re able to be far more flexible in rental rates, terms, and overall conditions of tenancies than corporatized property managers who can deflect blame to some nameless boss somewhere else. These narratives rarely make headlines, as small developers seek no glory and receive even less, but are nonetheless prevalent.
I wonder if this is also a problem caused by very low interest rates. With interest rates so low, banks aren't necessarily wanting to make riskier loans because if a company defaults on the loan,...
Banks don’t fully know who will be able to execute at the onset of a project. The best they can do is to work with developers who have a long established track record.
I wonder if this is also a problem caused by very low interest rates. With interest rates so low, banks aren't necessarily wanting to make riskier loans because if a company defaults on the loan, they don't have a higher profit margin from other loans to cover that loss. So they simply loan at a relatively low rate to companies they know will be able to pay it back. Cut out all the risk and enjoy all the, perhaps meager, profits.
In reviewing many dozens of financial models and development schemes for small builders every year, I’m constantly surprised (and heartened) by how many of them care deeply about the quality of what they build.
This is really good news. Developers who build without any consideration for the communities, infrastructure, and vibe of the areas they're building in aren't doing anyone a service but themselves. And really aren't any better than scalpers or shady used car salesmen. They act like it too, in the way they cut corners when building. Builder-grade windows, fiberglass ducting that degrades with use, generally bad ducting (and therefore heating efficiency design), etc.
Non-profit lenders [as a means of getting loans to small developers]
I like this idea in principle, but I dislike the idea of saddling non-profits with more of the risk so that banks can continue to safely make money. This is backwards. I'd be fine seeing some kind of government tax/fee on profit levied against the debt multiple1 (thereby disincentivizing larger developers from taking out loans they don't need) and/or having that tax revenue/fee be funneled to a pool of government-distributed (or NGO-distributed, in keeping with the article's idea) loans that specifically service smaller developers and NGOs seeking to provide low-income housing and other opportunities (for instance shelters, halfway houses, and other alternatives that would keep people off the street).
1 This tax/fee levied against the debt multiple would have to come into effect only on loans of a certain amount, say $1M since that's the example given in the article.
Banks make money on the spread between the rate they borrow at and the rate they lend at. When interest rates go up, it means their borrowing costs go up, and often faster since they borrow at...
Banks make money on the spread between the rate they borrow at and the rate they lend at. When interest rates go up, it means their borrowing costs go up, and often faster since they borrow at short-term rates. Some regional banks failed when interest rates went up.
If the interest rates stay high, the spread should eventually be higher, though, as they make new loans at higher rates. But in the meantime there are some scary numbers about bad commercial loans.
While this is true I wouldn't worry too much about it just yet. Most of the people actually on the hook for these loans are investors in commercial mortgage backed securities, not the banks or the...
But in the meantime there are some scary numbers about bad commercial loans.
While this is true I wouldn't worry too much about it just yet. Most of the people actually on the hook for these loans are investors in commercial mortgage backed securities, not the banks or the debtors. We will likely see more regional bank failures because some of them put their money into CMBS to chase yield (as the American commercial real estate market was insane for a while) but actually most of those creditors are outside of the US. They're going to get fucked over, there's no two ways about it. But that's the nature of holding the bag at the end of a bull run like commercial real estate during the "war for space" unfortunately, and it seems unlikely to translate into wider pain for the financial system.
Coincidentally, I just wrote up the framework for an affordable funding proposal yesterday, that would allow single family homeowners to fund secondary suites using government grants. Our Canadian...
Finally, we’ll dive into how America’s housing finance system is leading to negative consequences, privileging large scale institutional development at the expense of more incremental, community based building, and why we should work to support more of the latter.
Coincidentally, I just wrote up the framework for an affordable funding proposal yesterday, that would allow single family homeowners to fund secondary suites using government grants. Our Canadian gov just put out a round of "affordable" housing funding to the tune of 125M for 1100 units. That averages 113k per unit. Almost all this money is going to go to big developers and there are some serious questions about how many of the units will actually be 'affordable' since the definition seems to be a bit nebulous.
My proposal is that some of that money, instead of going to large developers, goes to SFH owners who want to develop a suite, typically in a basement or even a secondary dwelling unit, such as garden home. If it were a basement suite, in exchange for a range of grants for as little as 5k to install legal egress windows, up to 50k grant for egress windows, suite soundproofing, a second furnace and a secondary entrance the new landlord would agree to a reduction on rent, from 10% to 50% of fair market value depending on the size of the grant, and for set time, say 6 to 10 years. At the end of the contract the landlord is able to incrementally increase rent to fair market value.
The advantage, as this writer pointed out, is that people who live close to their development care a lot more about it than a big developer - especially if its in their own house. And the owner has a vested interest in the development being as well done as possible as ultimately the value and equity is theirs to keep at the end of the contract. Its also MUCH more likely to involve small local trades instead of the 'big boys' that big developers use, putting more money back into the local economy.
Finally, this type of development is much smaller and more nimble than big developments. Much of Canada is in a housing crisis with far too few units and far too many people seeking housing. Big apartment blocks often take 7 to 10 years to get built from vision to completion, but a basement suite can be done in a couple of months. 100 basement suites could be finished LONG before 100 suite apartment gets built.
Im hashing out the idea with a group of landlords before sending it on to our Minister of Housing. Might go nowhere, but its worth a shot.
From the article:
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I wonder if this is also a problem caused by very low interest rates. With interest rates so low, banks aren't necessarily wanting to make riskier loans because if a company defaults on the loan, they don't have a higher profit margin from other loans to cover that loss. So they simply loan at a relatively low rate to companies they know will be able to pay it back. Cut out all the risk and enjoy all the, perhaps meager, profits.
This is really good news. Developers who build without any consideration for the communities, infrastructure, and vibe of the areas they're building in aren't doing anyone a service but themselves. And really aren't any better than scalpers or shady used car salesmen. They act like it too, in the way they cut corners when building. Builder-grade windows, fiberglass ducting that degrades with use, generally bad ducting (and therefore heating efficiency design), etc.
I like this idea in principle, but I dislike the idea of saddling non-profits with more of the risk so that banks can continue to safely make money. This is backwards. I'd be fine seeing some kind of government tax/fee on profit levied against the debt multiple1 (thereby disincentivizing larger developers from taking out loans they don't need) and/or having that tax revenue/fee be funneled to a pool of government-distributed (or NGO-distributed, in keeping with the article's idea) loans that specifically service smaller developers and NGOs seeking to provide low-income housing and other opportunities (for instance shelters, halfway houses, and other alternatives that would keep people off the street).
1 This tax/fee levied against the debt multiple would have to come into effect only on loans of a certain amount, say $1M since that's the example given in the article.
Banks make money on the spread between the rate they borrow at and the rate they lend at. When interest rates go up, it means their borrowing costs go up, and often faster since they borrow at short-term rates. Some regional banks failed when interest rates went up.
If the interest rates stay high, the spread should eventually be higher, though, as they make new loans at higher rates. But in the meantime there are some scary numbers about bad commercial loans.
While this is true I wouldn't worry too much about it just yet. Most of the people actually on the hook for these loans are investors in commercial mortgage backed securities, not the banks or the debtors. We will likely see more regional bank failures because some of them put their money into CMBS to chase yield (as the American commercial real estate market was insane for a while) but actually most of those creditors are outside of the US. They're going to get fucked over, there's no two ways about it. But that's the nature of holding the bag at the end of a bull run like commercial real estate during the "war for space" unfortunately, and it seems unlikely to translate into wider pain for the financial system.
Coincidentally, I just wrote up the framework for an affordable funding proposal yesterday, that would allow single family homeowners to fund secondary suites using government grants. Our Canadian gov just put out a round of "affordable" housing funding to the tune of 125M for 1100 units. That averages 113k per unit. Almost all this money is going to go to big developers and there are some serious questions about how many of the units will actually be 'affordable' since the definition seems to be a bit nebulous.
My proposal is that some of that money, instead of going to large developers, goes to SFH owners who want to develop a suite, typically in a basement or even a secondary dwelling unit, such as garden home. If it were a basement suite, in exchange for a range of grants for as little as 5k to install legal egress windows, up to 50k grant for egress windows, suite soundproofing, a second furnace and a secondary entrance the new landlord would agree to a reduction on rent, from 10% to 50% of fair market value depending on the size of the grant, and for set time, say 6 to 10 years. At the end of the contract the landlord is able to incrementally increase rent to fair market value.
The advantage, as this writer pointed out, is that people who live close to their development care a lot more about it than a big developer - especially if its in their own house. And the owner has a vested interest in the development being as well done as possible as ultimately the value and equity is theirs to keep at the end of the contract. Its also MUCH more likely to involve small local trades instead of the 'big boys' that big developers use, putting more money back into the local economy.
Finally, this type of development is much smaller and more nimble than big developments. Much of Canada is in a housing crisis with far too few units and far too many people seeking housing. Big apartment blocks often take 7 to 10 years to get built from vision to completion, but a basement suite can be done in a couple of months. 100 basement suites could be finished LONG before 100 suite apartment gets built.
Im hashing out the idea with a group of landlords before sending it on to our Minister of Housing. Might go nowhere, but its worth a shot.