Home builders

Capital Risk Management Strategies for Home Builders

The right capital relationship is not only about the dollars funded, but it must also be reliable, offer flexibility and fit into a risk management strategy. The risk-return balance played by builders and developers is constantly changing, and today, new housing capital offers more options than ever before.

Through daily interaction with home builders and capital providers, I have insight into the opportunities offered by finance sources and what experienced builders are choosing to do during this current stage of business growth. industry. For many builders, these choices have become the normal course of business and a way to balance their strategy. With the availability of capital being important today, builders can play more than imagined, especially when the right relationship is found. The strategies below mitigate exposure, give builders more flexibility, and allow for expansion.

Land bank

Land banking offers home builders an off-balance sheet, low-risk opportunity to develop their project, as well as acquire finished lots. Land bankers, which are private equity groups, will purchase land on behalf of the builder / developer while securing funding for horizontal development. Once the builder has completed the horizontal work, the builder will buy back the finished lots from the land banker at a predetermined rate and withdrawal price. Interest may be paid in progress or may accumulate and be transferred to finished lots upon withdrawal. The builder deposits 10 to 15% of the cost with the land banker, which is returned to him pro rata when the lots are dismantled. This deposit is the only money at risk for the builder because the land banker owns the land, no loan is involved. Builders use land reserves as a gateway to access their vertical construction finance at a lower cost. It is a non-recourse tool that manufacturers are increasingly using to develop their business. Land bankers can be a great land capital partner. As one builder put it, “We find it a risk-free way to grow our business, we know how much risk there is and we don’t have to worry about warranties. ”

Build to Rent

Builders use single-family rental (BTR) as a low-risk tool for acquiring and developing land, as well as building and selling homes. Builders are evolving and changing business models, moving towards BTR not only because of the high demand for the product, but also because the capital available through various private equity funds is low risk, non-recourse, and plentiful. . Private equity groups offer builders a variety of ways to use their capital and expertise to develop projects, and these groups will contract to buy all the homes in advance. Not only does the builder have a capital partner but he also has an end buyer, all in one, with little risk. Private equity funds have become quite builder-friendly by engaging builders early in the development process and offering capital in a variety of ways. From providing all equity for the deal to purchase the land, and providing horizontal financing, these groups have gotten creative in acquiring homes for their portfolios. Builders sell houses at a predetermined price or build on a fee basis.

Earth light

Builders use a “light land” strategy to fill their pipeline with lots without risking having undeveloped land on their balance sheets. They use batch option agreements to secure finished batches with third party developers. This keeps their cost of owning land to a minimum and frees up capital for future projects, while mitigating their risks in the event of a market downturn. Along with this, many home builders develop strong relationships with real estate developers and become the developer’s first option to purchase their finished lots. The lightweight land acquisition strategy allows builders to control lots based on demand. Some builders will find vacant plots suitable for development and will partner with a real estate developer to develop the plot on their behalf. It’s a win-win situation. Not only does the real estate developer see his project sold, which facilitates the availability of capital, but the home builder secures his land pipeline according to his projections. For example, a developer I work with currently has several projects at different stages under contract with a large homebuilder, providing the builder with 1,000 lots over a 24 month period.

Limited and without recourse

Both limited-recourse and non-recourse options are more common in today’s lending environment and should be considered. Check with your lender about the possibilities and potential conditions. Many do not openly advertise this but have programs in place, or they may lend themselves to certain demands depending on the risk analysis. You can pay a little more in interest and the overall structure can be changed slightly, but the peace of mind and reduced risk are well worth it for many builders. There are A&D lenders who specialize in non-recourse, as well as construction lenders who have become competitive with a non-recourse option or more of a limited-recourse option with construction guarantees. Even when recourse is required by lenders, there are still ways to limit collateral through various exclusions and releases. You can request that various assets or even an asset be removed from collateral, and / or collateral released or reduced as certain benchmarks are met. It’s best to start the discussion with your lender early in the process and let them know that these issues can determine whether you will seek a relationship.

It is during these difficult times that risk management should not be overlooked by home builders. Diversifying business models and capital strategies can reduce exposure and create a more secure environment for the future.