Residential Construction Lending Solving Problem of Riches at Arixa

DEBTWIRE | July 2021 | 17:29 EDT | USA

The amount of institutional capital looking for residential business-purpose debt hasn’t let up this year but some of the opportunities have, leaving lenders to figure out how to meet the demand.

The opportunity to deliver to investors has rarely been greater, according to Greg Hebner, a managing director at Arixa Capital, a private lender that has originated more than USD 2bn across the West Coast. He estimated the amount of money earmarked for loans is exceeding what lenders can produce by 25x-50x.

“There’s way more capital wanting that product than there is product,” Hebner said, of residential fix & flip loans.

Meantime, the money sloshing around was a popular topic at the IMN’s annual single-family rental forum in Miami last week. In a social media post summing up the conference, CoreVest CEO Beth O’Brien, noted that “the market has never seen so much capital on the equity or debt side.”

So, what’s a lender to do? Follow the developers, they said.

The trend is decidedly moving toward construction lending as the hot demand for a sharply limited supply of homes is reducing the opportunities for flippers and the lenders that served them, said Hebner. The phenomenon became clearer in 1Q21 when flips represented just 2.7% of home sales, the lowest level since 2000, according to ATTOM data.

While Arixa is still active in fix & flip lending, its business mix is shifting quickly. Where construction lending was 10% of Arixa’s business a couple years ago, the share is 35%-40% today, Hebner said.

“There is a flood of institutional capital pursuing these types of loans,” Hebner said. “How do you fill that? It won’t be fix & flip loans so it will need to shift to construction lending or the rental side, which is a much larger addressable market.”

Per Hebner, Arixa isn’t pushing that shift but is following clients who see construction as their most compelling opportunity. As told to him by developers, margins are strong and the loans provide better returns than a fix & flip project where they might be just adding a few hundred square feet of space.

A common strategy for these developers is to tear down existing structures and redesign it to maximize the density of units in high-demand, land-constrained markets, Hebner said. Arixa also lends on larger subdivisions where demand is rising due to work-from-home policies and more flexible commuting needs, he said.

Among projects funded by Arixa are 24 new homes in Rialto, California, an 18-home project near Mammoth Mountain and similar ones in near Lake Tahoe and in Rancho Mirage, California, he said.

“These are markets that pre-COVID we would not have been lending in, but we are definitely seeing buyers looking at these locations,” he said. “Prices are strong and there is still a limited supply of high-quality new homes.”

The urban infill projects that were the basis for Arixa’s platform for the past decade are still getting financed but their sizes and complexity have increased, he said. Recent Arixa loans of that type include a 15-unit condo project in Los Angeles’ Silver Lake neighborhood and a 13-unit condo development in West Hollywood, he said.

Buyer and renter demand has been strong for new homes and prices and rents are above pre-pandemic levels, he said.

On that note, Arixa launched its own single-family rental and multifamily term loan products last month, again because its clients are increasingly turning to those projects, he said.

Arixa’s pivots aren’t unique, however.

Ground-up construction lending at Lima One Capital — the lender acquired this month by publicly-traded loan investor MFA Financial — more than doubled in the year through April to USD 30m-USD 40m a month, as reported. Churchill Real Estate is dedicating more capital to construction loans and Temple View Capital is expanding its construction loan products.

Toorak Capital Partners, the KKR-backed aggregator known for its fix & flip loan securitizations, is seeing its borrower base shift toward larger multifamily projects and just issued its first deal backed by single-family investor loans, according to the company and a bond rating report, respectively.

A potential limitation to construction lending is that the loans haven’t been embraced by bond investors concerned about getting their money back when complex projects go dormant. Fix & flip RMBS have included some ground-up loans, but they are generally limited to no more than a quarter of the collateral.

That may be changing, however, as bond investors are showing a willingness to take on risks tied to housing. According to Ryan Craft, founder and CEO of asset manager and bond issuer Saluda Grade, he’s got investors who are now “completely comfortable” with construction loans in securitizations, as reported.

Securitizations could be a game changer, according to Hebner. He sees construction loans as complex, but risks are mitigated by high amounts of borrower equity and because sponsors are typically experienced.

Hebner said he doesn’t see an expansion in the fix & flip opportunity any time soon without more meaningful supply from distressed sales or from homeowners who've spent the past year upgrading their houses.

“We just don’t see what would cause another redo” of the housing crisis of 2008-2009, he said.

by Al Yoon