Home builders have many pain points when borrowing from banks. Chris Tereo, Co-Founder of i Fund Cities, explains some of the pain points and the benefits of working with alternative lenders for residential ground-up construction projects. Watch the video or read the transcript below to learn more.
LENDER LINK:
What are some of the financing options available to home builders, and what are the benefits for each one?
CHRIS TEREO:
What we’re kind of seeing in the market in terms of, you know, capital that’s out there to finance, construction, ground up construction. And largely we’re talking one to four unit residential, which there is a massive need for in the country. So what you’re seeing is banks are a, that, you know, with SVB and all the other major banks you’re also seeing a tightening of guidelines. And what that means is maybe if you were at a bank 75% LTV, now you’re down to 65% or maybe not doing a deal at all, right? So as an investor, you know, you might say, Hey, I have a really good relationship with a local bank. So there’s two parts of this. There’s the person that already has a good relationship with a local bank and they’re able to fund deals and there’s their own challenges with those guys we will touch on. And then there’s also people that are looking to break into new construction. Maybe they’ve done a handful of fix and flips and now they’re trying to go start a new banking relationship and it’s next to impossible in most cases. So the so either way, which, if you’re the person that’s already doing new construction or you’re looking to get into it, here are the common pain points or issues with bank financing that you’re gonna come across. So one is leverage just and I’m comparing this to alternative financing, which is I Fund cities and other alternative financing out there. But we specialize in new construction financing. So what you’re gonna see is a leverage. So that’s loan to cost or LTV caps. Banks anywhere from 65% to maybe 75% LTC. And what that means is, we’re gonna touch on this in a, little bit, is that means you have to cover that gap.
So if the bank is gonna fund 65% to 75%, you need to put up 25% to 35% equity. You have to bridge that equity gap, right? So an alternative lender, like an I fund cities on new construction is gonna be in that 85%, basically 75% to 85%, we’re going to basically be 10% to 20%, sometimes more leverage on loan to cost. So what that means is your equity gap shrinks from 25% to 35% to, you know 10% to 15, which is a big deal as you’re doing volume right? Where if you’re raising equity, which is very expensive when you talk about rates with, and that’s a very common pain point using banks don’t turn financing, which we’ll get into, but equity is super, super expensive. And the less equity you need to raise, when you look at your total capital stack, when you actually run the mass side by side banks and i Fund cities, and you’re raising equity at 15% of the slog versus 35%, it actually makes a big difference and sometimes in favor of the alternative lender. So that’s leverage, right? Another common pain point with banks is deposits, right? So a bank’s like, yeah, you know, we’re super entrepreneurial. We believe in you, we’re gonna give you 75% LTC, which is on the high end, maybe call it 80%. And they’re like, yeah, this is great, but guess what? They’re gonna require you to have a depository account because that’s how banks have money to lend out, right? They have depository accounts. So yes, while they might be at a 75% LTC, which you think is good, you have to stick $200,000 in that bank, right? So what is your real leverage when you’re putting $200,000 in there earning whatever interest rate they’re offering today? And what is that actual blended LTC? So you have to consider that as well. And you’re just tying up an extra $200,000, $300,000 depending on the volume. You do X amount of dollars in a depository account, not earning interest very little. So that’s number two. And there’s four things, four, common pain point, the banks.
So then there’s also spec ratio, which is just a fancy way for saying the number of houses that you’re allowed to build at any given time. So banks will typically, cap you on the amount of, let’s use a 10 development, single family development or town home development, right? And a bank’s gonna say, alright, we’re gonna give you financing to build the first two, and until you get one pre-sold or finished and sold, we’re gonna cap you on the amount that you could build at any given time. A private debt fund, like an i Fund cities alternative lender, we’re gonna look at the sponsor’s previous ability to execute your liquidity, not tax returns, but your liquid cash to do a given deal and the project itself. Does this project make sense? And as long as those things check out, we’re gonna be more aggressive on the spec ratio or the amount of houses we will let you build at a given time. If you have the ability to execute and the cash to do all 10, great. If it’s five at a time, great, but we’re gonna be more aggressive and we see this all the time across the country, where banks sort of fall down sometimes. Last point is the exposure limits. So if you’re an investor developer, and you’re doing this at scale and you’re do doing production bills, you know, maybe the bank’s like, yeah, they got me great. Leverage my rate’s, you know, low enough. Which is probably prime plus one prime plus a half a point, which is not far off from where we are right now. But yeah, everything’s great except the exposure limit. They can’t grow and continue to grow and scale the business at the rate at which they want, because the bank ultimately, let’s say the spec ratio is even semi-decent, they might only be capped at a $5 million or $10 million depending on how big you are, exposure limit at any given time. And when you have a private debt fund like an i Fund Cities, our exposure limit is higher.
So, to recap this, I do wanna say it’s super important to diversify your lending partners. Like I’m not sitting here saying banks aren’t good, don’t work with a bank. I’m not saying that in fact you should definitely have a good banking relationship, but how do you diversify your lending partners at an IFC or alternative lender to your lending corner or your capital stack so that when banks decide to shut down overnight or they decide to limit their exposure in a certain market, you’re not left trying to pick up the pieces and your business doesn’t suffer. You know, people that use banks, obviously we always say we’re never gonna compete on rate, but we’re gonna compete on speed, leverage, and overall efficiency and scalability, right?
LENDER LINK:
Do home builders generally put up with all the pain points of working with banks just for the benefit of lower pricing?
CHRIS TEREO:
Yes, banks are typically at a prime plus half a point or one point. But when you actually run, like I mentioned before with that capital stack, when you put a 9.5% – 10% bank rate loan with filling 35% of the equity versus an IFC loan at maybe, you know, one to two points more expensive, and then you’re filling 15% equity and you actually run that math, sometimes it actually is more cost effective to go with an alternative lender, especially when you factor in the speed of just closing draws everything else.
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