Banks’ New Policy: No to American Family Homeownership?
This article was originally written in 2011 for the Houston Business Journal.
Attempting to fix the problems in the mortgage market, Congress and the Administration need to use market forces and successful state policies as their guide, while protecting market fundamentals from over-reaction.
To protect their interests from further exposure, banks changed lending practices in the real estate markets, reducing real estate loan portfolios — even selling performing loans at a discount. By intentionally eliminating commercial and residential real estate from their portfolios, banks are ensuring a future shortage in single-family lots that will drive up home prices and hamper any recovery. If not addressed in new policy, this over-correction will reverse the greatest wealth producing mechanism for American families: home ownership.
Most homebuilders want to deploy their capital in constructing and selling homes. Before this can happen, another developer must buy the land and invest capital in the streets, sewer, water and other infrastructure required for a single-family lot development.
Initial bank responses to the mortgage crisis were aimed at ensuring that mortgage customers were qualified: increasing the minimum threshold for credit scores and income levels, and requiring additional escrow funds by existing mortgage holders, as security against default.
Developers altered their plans to meet consumer demand, scaling back the number of developed lots and creating home designs with fewer rooms and amenities – adjusting to the new economic reality. Nevertheless, lenders exited the single-family home development market.
The question now becomes: have banks unilaterally determined that the era of homeownership for American families is over?
States that instituted parameters for loan-to-equity ratios did not experience the collapse in home and mortgage markets like states allowing homeowners to take out 100 percent or more of the appreciated value in their homes. Guidelines must be instituted as an industry standard to allow for rational borrowing and more secure lending for home purchase.
Likewise, speculative home development unconnected to market demand fueled the crisis. With the nationwide mortgage crisis of 2008, national housing starts declined sharply. Banks stopped lending to residential real estate developers – even to those whose plans for new single-family homes were directly connected to market demand.
As banks collapsed and were re-structured by the FDIC, the initial banks’ obligations hung in limbo. Even if developers acted in good faith, and were on-schedule with profitable projects, developers were left without the funding they had secured in loan agreements with the initial bank. Successor banks did not assume the initial bank’s liabilities in real estate construction or there was the request from the lender to “move” the loan to another bank – a daunting task in an industry reducing real estate exposure. Unlike banks, developers did not get a bailout.
Implications for future mortgages, developments and contracts due to the retreat from real estate markets are far-reaching and destabilizing. What developer would seek funding if the threat of unilateral cancellation were implicit in the loan agreement? What developer would fund a project in its entirety to avoid partnering with an unreliable lender? Two unintended consequences will result: developers will halt activity in the single-family home market, and new, higher cost lending entities will develop outside of the current regulatory system. Both possibilities will destabilize the economy, retard recovery, increase overall construction costs and sow the seeds of the next financial crisis.
Still, banks and regulators do not have to follow this path. Market forces already are impacting the scope and quantity of the developments. Developers can make the case for a given project, but they need willing financial partners. Lenders can establish market-based criteria and can work together with qualified developers on specific projects to avoid this future predicament.
Rationality must be returned to the marketplace – a guiding principle that fuels sustained growth and discourages speculation and panic. Government entities should set limits on the loan-to-value ratio and not force banks to make loans to unqualified applicants for non-economic reasons. Congress should impose a regulatory regime on non-bank lenders who fueled the crisis by granting loans at twice the bank rate to applicants that could not repay them to purchase over-priced houses.
While some areas the single-family home market is over-stocked, this is a market-specific phenomenon. In fact, there are municipalities that have viable economic development plans based upon sound research and vision. Banks should invest in new single-family developments in these markets –facilitating continued economic growth of an area.
In other words, one size does not fit all. Fear need not determine our reaction to a crisis. It’s time for banks and regulators to stop over-reacting and bring rationality back into the conversation. We have the opportunity to minimize the negative impact of over-reaction and support recovery by allowing developers to prepare the sites that will someday become single-family homes. Without willing and reliable financial partners, however, our economy will continue to be stuck.
Public-Private Partnerships - Breaking the Status Quo
I have had experienced Public-Private Partnerships (PPPs) from both the public and private side. From my work as a real estate developer, I knew a great many qualified developers doing good projects all around the country. As I listened to these developers speak about their projects, I noted that the vast majority were only tangentially tied to a public entity. At the same time, while working and traveling as Mayor of the City of Sugar Land, Texas, I met a great many energetic and talented local leaders, each with a vision for their particular community. These visions included clear sets of goals and specific projects, yet for some reason, these goals were not always being achieved. It became obvious that opportunities were being missed due to a lack of understanding, on both the public and private sides, of the respective needs, values and opportunities that each could offer. I realized that part of the reason for this void in understanding lay in the difference in approach to questions, as well as needs, roles and responsibilities, not to mention the differences in background, experience and skill sets that each brought to the table.
As I reflected upon the projects I had worked on as a developer with cities, as well as city projects I had facilitated as a Mayor, I asked what had worked and why? Also what didn’t work and why? Where there were failures? Where there were successes? I asked myself, was there any common thread to failures and successes? How could I take a fresh look at things to provide focus on the opportunity for a PPP for the benefit of both developers and communities?
Having been on both the public and private sector sides of the development equation, I knew from experience that a PPP does not make a bad project good, rather it can make a good project possible … especially in the tumultuous economic climate in which we presently operate.
PPP does not make a bad project good, rather it can make a good project possible …
I also knew that there are well-intentioned people on both sides of the discussion, but that there was a better way to approach the question of development. It requires a commitment to the final outcome, recognition of the differences in both parties, an openness to communication, some innovative thinking, an openness in approach and a good deal of listening. In short, getting to that “win-win” situation requires a commitment to building relationships and a focus on the end game. I wanted to demonstrate how the public and private sectors can work together to create new developments which achieve the mutual and respective goals, increase economic activity in a specific area, attain a required internal rate of return for developers, and in the end, deliver a better life for all residents of the area.
In order to accomplish this, however, we must break the status quo and broaden the universe of our partners. In expanding our list of partners, I am not necessarily referring to the classical sense of investment equity partners, but let’s look to bring other public-sector partners to the table such as the Municipality, County, Public Improvement District, Management District, etc.
Municipalities are beginning to craft their own visions of what they want their futures to look like – from small towns to large cities. These vision statements, or “comprehensive plans” can be used to direct development projects and funds, encourage economic investment by targeted companies, or identify areas of the city that need new development or redevelopment. Often times, these vision statements, which very easily could include a student housing component in a larger master-planned development, are paired with development incentives or economic development funds that aim at facilitating the realization of this vision – resulting in additional benefits for developers that seek to meet the vision. These statements are created after a process of community input, professional evaluation of the applicable economic factors, and a review of the area’s existing resources and benefits. For developers, these documents present opportunities to create partnerships with the relevant public entities and fulfill the residents’ collective vision while creating economic opportunities for citizens and a higher return on investment for the developer.
When partnering with a university on a student housing development, the PPP discussions generally evolve around pricing, investment returns, resident life programs, Freshman-on-campus programs, master-leases, marketing characteristics, etc. The discussion does not center around how many jobs am I creating, or what is the incremental increase in Hotel / Motel Tax, Sales Tax, Ad Valorem Tax, etc. However, by broadening the list of public sector partners, a developer is able to add to this “discussion list” a few additional items, such as economic development tools, incentives, grants, tax abatements, etc. In short, additional contributions that can be added to the developer’s capital structure, without the incidence of ownership dilution.
Several of these mixed-use projects can include student housing, and be part of a larger mixed-use facility that can combine retail, hotel, convention center, parking, sporting and entertainment venues, office space or other features. Of course, the student housing developer can stay focused on their industry segment, and a master developer can secure other “industry specific” partners to focus on the other development components. Yet collectively, all of the individual developers win by the shared infrastructure, incentives and reduced cost structure. The common thread that runs through all of these PPP projects is that the public sector’s support is leveraged to facilitate increased economic activity that can be a catalyst for positive impact of job creation, increased property values in the surrounding area, greater ad valorem taxes collected from sales and property taxes, higher average income, and more school taxes collected. These benefits justify the risk that the public sector will take.
For a developer, the advantage of entering into a partnership with various public entities is that it decreases the developer’s risk by filling in financing that would otherwise need to be covered by a developer’s own investment in a project. Therefore, a developer can minimize their exposure and maximize the internal rate of return through this type of partnership. Most importantly, by creating this partnership, the developer then gains access to additional political support, as well as additional public finance resources that can help to cover different aspects of a project’s costs.