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New rules for the new-construction market

 

Like much of the real estate market, the new-construction sector is starting to turn a corner. Builder confidence, buyer interest and construction lending are all on the rise. However, after being beaten down financially during the downturn, builders today are more inclined to pass along the onus of obtaining financing to buyers as opposed to providing it themselves.

Positive trends all around

Mike Kinane, senior vice president for retail lending products with TD Bank in Cherry Hill, N.J., says that the bank is seeing about a 20 percent increase in construction lending in 2012 compared to last year. He attributes the increase to rising confidence on the part of buyers who feel better equipped, in part thanks to record-low mortgage rates, to handle the added costs of new construction.

But it's not just buyers who are feeling more confident -- home builders are the most confident they've been in years. According to the National Association of Home Builders/Wells Fargo Housing Market Index, builder confidence is at its strongest level since near the peak of the market in June 2006.

Furthermore, with housing starts and building permits at their highest points since July 2008, construction activity is definitely on the rise.

But despite the positive trends in recent months, builders remain guarded against potential losses and have thus changed the way they fund new projects.

Brave new market

Construction was the one of, if not the hardest-hit industry following the downturn. Before the recession, many big builders had their own finance companies that made loans readily available to prospective buyers. But builder finance companies were depleted during the downturn leaving financing options through builders far less available.

Perhaps that's the biggest change to the new-construction market today verses yesteryear: more buyers are the ones responsible for securing financing, not the builder. And with such strict lending conditions, securing a construction loan today is no easy task.

Another change that comes with an improving construction market is the amount of incentives builders are offering. Not that long ago, builders were throwing in everything from new appliances to brand-new cars to get buyers in the door. Now, according to industry sources, these incentives are beginning to disappear as the market continues to improve.

Stephen Melman, director of economic services with the NAHB in Washington, D.C., says incentives have "backed down from the peak. It's not quite as many and the value of the incentives isn't quite as great." For instance, builders may offer some additional items that the buyer will appreciate but don't cost too much, such as an upgraded cabinet or a bit of landscaping.

Another interesting change has been the increase in the size of new homes. A recent survey from the American Institute of Architects' (AIA) found that: 8 percent of surveyed architects said they are building larger homes than they were last year. "This is significant because it represents a reversal of a trend that has been going on for six years," said Kermit Baker, chief economist for AIA in Boston.

Martha Finkley, senior manager with national homebuilder KB Home in Los Angeles, agrees, saying in an email that the average square footage of their new homes has increased over the last couple years. The average square footage of KB's new houses in Sacramento alone has gone up 24 percent in two years.

Financing new construction

Most banks offer what's known as a construction-to-permanent loan, which allows buyers to finance both the construction costs and the mortgage itself. During the construction period, the loan is typically interest-only and has a slightly higher interest rate than a standard mortgage.

Typically, lenders dole out the funds for construction to the builder in a series of installments over the construction period. The lender will make periodic inspections to ensure the construction is done properly.

According to the NAHB, a construction-to-permanent loan has several advantages, including offering "buyers some valuable bargaining points for obtaining a lower sales price."

New-home buyers struggling to come up with a sizeable down payment should consider FHA or VA construction loans, says Melman.

Buyer advice

Daria Pestone recently took out a construction-to-permanent loan with TD Bank to build a four-bedroom, four-and-a-half bath house in Greenwich, Conn.

Pestone found a builder who offered personalized service and fit within her family's budget. In addition to saving for a down payment, Pestone advises buyers to save for the surprise costs they're bound to encounter. "Building your own home is an overwhelming process," she says. "I recommend really researching the builder. Make sure to have your financing in check. A lot of surprises can come along."

As well, make sure that you've settled on a general contractor or builder before you start looking for a mortgage lender, since the lender will be looking for this when they are underwriting the loan, explains Kinane.

About the author:

PoonkaPoonkulali Thangavelu is a financial writer who has covered real-estate finance topics for several years. Her work has appeared in leading industry publications National Mortgage News, National Real Estate Investor, Asset Securitization Report, Multi-Housing News and HousingWire. She has also been published on Seeking Alpha and Yahoo! Finance.

 

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