Lenders in the construction market hold their breath as economy reopens

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Financing for custom-home construction, which dried up after the coronavirus outbreak began, has as much riding on the success of the reopening of the economy as any loan segment, if not more.

There's certainly some room for optimism: Builder loan applications financing new homes were up almost 11% year-over-year and 26% on a consecutive-month basis in May, according to numbers the Mortgage Bankers Association released Tuesday.

That represents a significant rebound from April, when these loan applications were down 25% from March and 12% from a year earlier.

During those first months of the outbreak, when restrictions on construction work and other social distancing measures were at their height, some investors and lenders suspended related lending programs altogether, said Jim Fraser, commercial real estate director at Built Technologies.

"Most of that suspension was related to construction halts, but it was also related to the availability of third-party services," he said. These included inspections, appraisals, general contractor bids, and supply and labor.

"All those peripheral components that are required to underwrite loans were, in some form, not available. So lenders had to pause those programs until that got resolved," Fraser said.

Now some of these programs are starting to get underway again, and the National Association of Home Builders anticipates modest growth in purchases of new custom-built houses.

"We had a short pause, but business is ticking right back up," said Amy Ellis, senior vice president for commercial lending at Hyperion Bank.

Difficulties in securing permits and inspections were the largest obstacles for issuing construction and renovation loans at the Philadelphia-based Hyperion, according to Ellis. With these hurdles more or less cleared today, the bank has resumed portfolio funding of such loans, with some underwriting restrictions to account for increased performance risk related to the coronavirus, she said.

There are signs that underwriting risk continues to constrict the availability of some construction and renovation lending more broadly.

Carol Lynn Upshaw, a senior loan originator at Hyperion Bank’s new mortgage company affiliate, said she personally finds investor programs outside the bank to be scarce.

"COVID has really changed our industry, and even when there is no COVID, these are complicated loans," she said.

Some programs remain shuttered. American Financial Resources' wholesale channel, for example, has suspended its one-time close program, according to a statement on its website. The company confirmed the closure, but declined to comment on it.

The rebound in the construction and renovation market also has regional variations.

The majority of Hyperion's client base, for example, is in the Southeast, which has had few coronavirus-related restrictions on construction activity compared with certain areas, including parts of the Northeast and Washington state.

Other areas of the country have faced more challenges in that regard, but there are signs things are improving.

More than 4,000 projects across Washington, Massachusetts, New Jersey, Louisiana, Kansas and California were affected by government-imposed construction halts, according to Fraser's assessment of consumer-dominated loans in Built's system.

Now, only a little over half those construction halts are still active and Fraser expects that number to be nearly halved again by the end of June.

"The initial shock of the pandemic that we saw in March and April looks like it has really kind of worked its way through," he said.

The coronavirus-related damage to construction lending overall could be manageable if there isn't too much of a resurgence in infections, and if government efforts in supporting consumer spending remain effective enough to continue driving purchases of new homes.

Activations on Built's system reflecting newly closed loans rose on a consecutive-month basis between February and March, March and April, and April and May by 6%, 14% and then 20%, respectively.

This uptick during the spring buying season and the Mortgage Bankers Association report on construction loan applications suggest coronavirus-related restrictions on construction lending may have been offset by record-low mortgage rates and pent-up demand in a market with limited inventory that has only gotten tighter in the past month.

New authorizations for homes decreased 8.78% on a consecutive-month basis in May and were down 6.89% from a year earlier, according to BuildFax. In comparison, new authorizations for homes in April were down 7.37% from March but up 1.2% year-over-year.

"We thought [the coronavirus] might throw a severe cut into the housing market, but — knock on wood — so far it really hasn’t emerged," Fraser said.

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