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As the coronavirus pandemic is tightening its grip on the country’s economy, which has now reportedly tumbled into a recession, the construction industry is now facing intensifying headwinds that are rippling through the housing market as well as the financial sector.
As of Monday, according to Built Technologies, which provides lenders with real-time data on their construction portfolios, over $4 billion worth of construction loans – out of a total of $17.6 billion the company surveils – cover residential and commercial properties in locations where building has halted.
Halted construction projects make up 16% of the over 29,500 loans in Built’s system. Both impacted loan volumes and counts grew with about 5% in less than a week since April 1.
“It’s a pretty significant impact,” says Jim Fraser, Built’s director of commercial real estate strategy.
It is also an effect that is spreading quickly as states, counties and cities enact “shelter in place” orders that do not widely identify construction as an essential business, thus effectively shuttering projects.
According to the National Association of Home Builders, Washington, Michigan, New York, Pennsylvania and Vermont do not consider construction an essential economic segment. Neither do cities such as Boston, Washington, D.C. and Atlanta, among others (the latter two only allow maintenance and repairs).
Built Technologies map shows residential and commercial construction projects, which were halted as … [+]
Built Technologies
Even if construction continues under local directives, the industry is under pressure due to disruptions in the labor market and in global supply chains. According to the Bureau of Labor Statistics, overall construction employment dipped in March, although the residential sector add 2,000 jobs. At the same time, international trade interruptions have stymied imports of countertops, finishes, steel and other building materials from countries such as China and Italy, which have grappled with large COVID-19 outbreaks.
Why is construction loan performance important?
When construction slows down or stops altogether, buildings take longer to finish.
Yet, builders and developers, who finance their activities through construction loans, operate on tight schedules that allow them to access money through disbursements – or draws – that occur at slated milestones such as laying the foundation, framing and electric wiring.
An inspection precedes each draw, which often postulates that borrowers only pay interest on the funds until they wrap up construction. Once the latter occurs, the construction loan converts to a mortgage.
The process is similar for consumers, be they investors or families, who finance the renovations of properties.
When projects stall, construction loans could turn delinquent, potentially leaving lenders with little to no collateral to make up for the losses (the way they typically would when they foreclose on an existing single-family house, for example).
“Imagine that I make a loan to you and you’re going to build a house in nine months, and you don’t complete it in nine months,” says Fraser. “It takes you longer. Well, that’s a violation of the covenant alone. That’s a default.”
Moreover, any funded improvements might be rendered null – and a drain on the loan – if the building is not properly and timely enclosed with a roof and walls.
“That’s why construction loans that don’t complete are so risky,” Fraser says.
He adds, “In 2007- 2008, the largest losses in the banking sector, besides subprime mortgages, were construction loans, mainly construction loans that were stopped, then become this very volatile asset on the banks’ and lenders’ books.”
What are lenders doing today?
Compared to the Great Recession, lenders today follow stricter rules intended to avert another financial crash.
However, as part of the CARES Act, which provides a record $2 trillion in economic stimulus amid the coronavirus pandemic, the federal government relaxed some of the standard regulatory requirements for defaulting construction loans.
Still to come, though, is complete data on construction-loan interest payments since the start of the coronavirus, which would cue to borrowers’ financial circumstances.
Nonetheless, construction loan servicers now have leeway in troubled debt restructuring (TDR), which provides defaulting borrowers with significant concessions such as repayment plans, interest-rate adjustments and forbearance periods.
Usually, “when that happens, a loan is downgraded to a problem asset,” Fraser says.
However, most loan exceptions offered to COVID-19-impacted borrowers, who were current on their payments prior to the relief, would not be considered TDRs.
“The government’s trying to help the banking system provide tolerance to defaulting loans,” Fraser says. “I think that can go on for some time. But ultimately, the economy is going to have to turn around and people are going to have to get back to work. Buildings have to be completed, people are going to have to pay mortgages.”
The speed and shape of the recovery would be crucial, Fraser says. Right now, however, the pace of the economic unraveling troubles him.
“If you look back at 2007 – 2008, it took almost three quarters – [there were some crisis points along the way] – for the financial system to fully get to ground or for the plane to crash, so to speak,” Fraser says. “This one is going straight down in four weeks. The unique thing is the speed of the change.”