Boarded up corner store in New Orleans

First off, let’s be clear in the terminology. Banks don’t invest. A bank will sell you a construction loan to build/rebuild if you and an investor put up 20-30% of the project cost. A bank will sell you a mortgage to retire the construction loan for 70-80% of what the building is worth once it is completed and leased.

Banks don’t invest. Banks lend money, secured by an asset the can sell to recover their loan amount if you default on the loan and the have to foreclose. Banks are not doing you a favor. They need to sell you a loan. That’s how they make fee income. That’s a big part of their business model. A loan officer on base salary plus bonus is basically a commissioned salesperson. (They are just selling loans and not automobiles).

Banks do not invest. An investment carries significant risk that you will lose your principal. It is not secured, collateralized, or guarantied. It is not insured against loss.

When a bank sells you a construction loan to build or renovate a building, or a mortgage on a completed building, those loans are secured with the borrower's asset, something the bank can take in the event the borrower defaults on the loan, along with a personal guaranty from the borrower that the bank can enforce if the foreclosure and sale of the asset does not cover the amount of the loan.

Where they make loans and on what kinds of projects varies from bank to bank, but again, banks are not making investments. They are selling loans funded by their depositors cash or cash they borrowed from the Federal Home Loan Bank or similar institutions. They have to maintain loss reserves of 10% against the loans they make. The cash their shareholder's have invested in the bank is used for those required loss reserves.

Now, if your question is "Will banks sell loans to people working in downtrodden areas?" my answer is yes, but the terms of those loans will be adjusted based upon the risk of a default the bank's underwriters see in the downtrodden area.

Those loans will require robust guarantees from individuals with significant net worth. Those loans will probably be for 50-65% of project costs or an even smaller portion of the capital stack because appraisers need comparable sales of building values in the area to comply with the standards of their practice.

If you are one of the first people building/rebuilding in a distressed neighborhood, you will be more likely to use private lenders and equity to do the first couple projects to establish data that can be used by the local appraisers. Banks are required to use the appraiser's opinion of value as the starting point for underwriting the loan. The opinion of value establishes what the asset is worth in case they get it back and have to dump it in a quick sale.

Early developers take on the risk that the distressed neighborhood may not support rents sufficient to support the costs of new construction, which is why we recommend that small developers focused upon the distressed neighborhood start small, with something they can live in if necessary.

Distressed neighborhoods typically need more than supportive appraisals, investment of social capital, the time and attention of the small local developer become the basis for building trust. Find work for folks in the neighborhood. Connect your rookie plumber with a decent bookkeeper, pick up trash and litter on the regular without fanfare.

The trust of your neighbors is a competitive advantage for the small operator for when the big developers from the other side of town or from out of town show up because the small developers have done the heavy lifting of proving the market and establishing comparable sales and NOI/cap rate data for the appraisers to use for larger deals.

The people who already live in distressed neighborhoods are in a position to learn the skills required to build/rebuild is they start small and build a culture of local collaboration. Investors invest. There is no shortage of folks willing to invest in a sound real estate project with a solid operating partner. An investor with a connection to a distressed neighborhood may have personal reasons for wanting to invest there.

Snout Houses with no front door.

Today I saw a lot discussion and concern about a potential housing bubble in the Facebook chatter among residential realtors.

All over the Atlanta region we continue to see rapid increases in house prices and rents. Folks are wondering how long this is going to last. Toward the end of the piece linked below, (part one in an excellent series of five from Strong Towns) there is a breakdown of housing production in Atlanta, by Eric Kronberg. I think a similar breakdown probably applies to the larger Atlanta metro.

With 50,000 people moving to the region every year we cannot keep up with that demand on the production side of the enterprise. That keeps inventories very low and prices high. Why are we so far behind on production of new housing? The biggest reason is a serious long term shortage of skilled construction labor. Remember, there was little or no work for these folks during the Great Recession. So people retired, changed their line of work, or returned to their country of origin. The shortage is not surprising. What would you do if you could not find work for five years?

With the labor shortage, productivity in residential construction gets hammered. It takes longer to get anything built if you can’t rely on your trades to show up. Construction schedules get stretched with nobody working on the site as projects compete for the scarce resource of people who can build.

Costs rise dramatically, but while lots of folks in the trades are charging more, many are making less money at the end of the day because they can’t finish the project when other trades don’t show up for weeks at a time. A plumber I know had his crew completing work on 30 houses last year, even with the pandemic. This year he says he’ll be lucky to work on 18. His overhead is the same with that reduced throughput, so he is making less money per house. -and his best plumber went to work for someone else. Let’s not bitch about the cost of construction and ignore the really low levels of productivity we should expect from the folks doing the work because there just are not enough of them to go around.

Add supply chain problems to the shortage of skilled labor and the problems of low levels of housing production are going to be with us for a while. Beyond the significant short fall in housing production, the types of housing being built are skewed to the higher end market segments.

Starter homes and Multifamily are not getting the attention needed, so the range of housing types being brought to market is impacted. As for a bubble, I think we have more immediate problems. The gap between how much a service worker is paid and how much it costs to keep a roof over their head gets worse every day. Atlanta is moving from its familiar position as a vital city with a lower than average cost of living and a great workforce, toward being a city with a high cost of living and workforce shortages. We will continue to see rapid appreciation in home prices and increases in rents because people will continue to move here in large numbers and we cannot build fast enough to provide housing for them. The construction labor shortage is going to be part of our reality for the next 5-10 years.

While folks in Atlanta can continue to speculate, betting that the price of their house is going to continue to increase rapidly for the foreseeable future, the lack of housing production outside of the high end market segments is going to cripple the regional economy and force people who cannot afford to live inside the Perimeter to endure ever longer commutes from the surrounding rural counties.

You think traffic is bad now. Force a quarter of the population to drive to cheaper housing and see what happens…. The fundamentals are out of whack and the folks with less resources and fewer opportunities are going to bear the consequences. So what can we do about that? The 5 part series from Strong Towns presents some neighborhood scale answers and some hope.

Where did all the small developers go?

I continue to be impressed with the silly and rather elaborate mythology otherwise intelligent people whip up around housing and money.

For example:

Podium buildings with elevators cost more per SF to build than three story walk up buildings. Concrete and steel mid rise building cost even more per SF than podium buildings.

How many times have you seen people lose the minds of the construction of podium or mid rise buildings—claiming that “this is going to make housing unaffordable!”

Okay. First, coincidence is not causation. When there is less sunshine I am more prone to depression. I did not make it rain by feeling bad….

Real estate math is relentless. You can’t construct buildings that cost more per SF _until_ housing becomes unaffordable.

When rents increase to the point where they can support a more expensive form of construction, and it looks like there are plenty of people willing to pay higher rent to live in a desirable place, that’s when you can build a more expensive building.