Financing Options for Small to Mid-Sized Builders
Access to capital with reasonable cost is essential for small and mid-size builders to grow their businesses. Since the financial crisis a decade ago, large volume builders with lots of cash are providing increased competition and are moving in on deals they historically stayed away from, gaining market share each year.
Although many banks have pulled back on lending, there are newer, alternative funds and resources that are becoming more mainstream for small and mid-size builders today. Here is a look at some of these options and strategies that can help fund and expand your business.
Debt Funds – These alternative sources are prevalent today and seek experienced well managed builders. High loan to value ratios, 75% to 85% on land and construction which could mean up to 90% loan to cost depending on appraised value. These funds are aggressive and seek business. They have slightly higher interest rates and loan fees and are not regulated, caring more about the builder’s experience and project than financial statements, however they will review and some have liquidity requirements. The approval process can be fast as they don’t want their capital sitting idle. When dealing with debt funds always negotiate loan terms and structure as these funds are competing for business, and ask about how loan extensions and modifications work if needed.
Equity Funds – The equity groups today seek experienced builders, are smart and can be a partner to your success. Most have very specific preferences regarding deal size and location, and can be flexible on terms as long as they achieve their desired returns. Some groups like to fund equity to the mid-size builder preferring $3 million to $5 million in project funding, while others like to fund $10 million plus. Smaller equity amounts can be obtained as well. You have to seek out the groups that like home builders, versus other real estate.
Family Offices – Family offices are gaining traction as a source for JV partnerships and equity. These offices manage the wealth of high net worth families and look for co-investment opportunities, seek diversification and like real estate & home building. Family offices have increased tenfold since 2008, according to Forbes, and are now capable of making transactions that were traditionally reserved for big companies or private-equity firms. Forbes continues by quoting that they are “as quiet as you possibly could find”, but “they’re writing extremely large checks.” My experience working with family offices is they are accessible and seek deals. Most don’t market themselves so you have to be proactive in your search or seek introductions.
Smart Land Strategy – NVR, Inc., one of the largest home builders in the country, is the the only public home builder with a primary business model of purchasing finished lots, many of which are acquired on a pre-sold basis. The firm has the highest return on invested capital in the industry and is more profitable than many of its rivals due to its strategy of not acquiring and developing land. The firm uses Lot Purchase Agreements which are lot options to secure finished lots with a third party developer, without closing until needed, if desired. They use cash or letters of credit for deposits required. So they don’t acquire raw land for development and don’t acquire a substantial number of lots per project at a time. This keeps their land carrying costs to a minimum, frees up capital for future projects while mitigating their risk in a market downturn, which is why there were able to turn a profit during the financial crisis. The strategy allows them to maximize inventory turnover and operate with less capital which enhances their rates of return on invested capital. While not a financing option, I find this acquisition and capital strategy intriguing for the small to mid-size builder.
Model Home Sale/Leaseback Program – There are new funds that will purchase your model homes at approximately 85% to 90% of appraised value then lease it back to you at a reasonable monthly rate. Builder pays insurance, maintenance and utilities like a triple net lease. This amounts to a non-recourse model home financing strategy which increases your cash flow, allows you to pay off debt and recaptures your equity. Upon sale you have an agreed upon profit split. This reduces balance sheet exposure and frees up capital, a real beneficial strategy for many builders.
Entrepreneurial Banks – Don’t shun the small banks. Many local, smaller banks are lending to builders and are very active today. Approval process is short and you deal with presidents and main decision makers. All banks have different strategies so talk to many. I’ve seen 75% LTC on spec homes up to $7 million sales price. They are more concerned with the person, relationship potential and project than stellar financials. The banks also feel construction completion and budget adherence are a risk so show how well you’ve performed in the past.
Impact Investors – This is a new breed of investment group looking to make an impact on a cause or social issue as well a make a profit. These socially responsible funds make decisions base on risk, reward and the amount of good contributed in the world. If your project will make a unique impact on a local community, or you have a uniquely sustainable type of project, or have a specialty project with a do-good cause, these resources may have an interest to invest.
As with all financing partners make sure you negotiate terms and get the details on how they handle the loan if your project performs slower than expected.
Small and mid-size builders play a vital role in the industry, delivering some of the best, high quality, most unique projects while boosting the country’s economic growth. Investment in this sector is a wise choice and many financing sources are believers.