By JOSEPH D. PALUMBO
Lockdowns and other COVID-19-related shifts in societal norms have changed the landscape of commercial construction and proved challenging for contractors and lenders alike over the course of the past 20 months.
It is well documented that the construction industry is facing increased costs and uncertainty resulting from supply chain issues, tariffs and shortages in skilled labor and materials. The prices of steel and lumber continue to be volatile, and they are also affecting the costs of fabricated materials and equipment. Natural gas, crude oil and other energy materials are rising in cost as well. In addition, difficulties finding and retaining skilled workers are compounding the industry’s issues and causing frequent disruptions. All these factors can make it difficult to complete open projects and harder to predict capacity to take on new projects, leaving some developments crawling and others with uncertain start dates.
The lending industry is dealing with its own pandemic challenges, including a rise in loan defaults in certain sections, restrictions mandated by foreclosure moratoriums and additional regulatory concerns. While new options for borrowers provided by the CARES Act like the Paycheck Protection Program certainly helped banks weather the COVID storm, banks still face a number of challenges including regulatory scrutiny and an economic environment that is quickly changing.
Construction Lending Amidst the Onset of the Pandemic
In early 2020, at the outset of the pandemic, the lending industry revisited underwriting requirements and became more selective. Lenders scrutinized builders’ track records and capacity to take on projects more than ever before. Some became reluctant to fund new projects given widespread shutdowns and societal impacts caused by COVID-19. Creditors and regulators also started paying more attention to construction budgets, especially the amounts reserved for contingencies, to ensure projects had the cash needed to reach completion. Traditional conditions precedent to lending like loan-to-value ratios were conservatively adjusted to take non-traditional factors such as the pandemic into account, and banks at times asked borrowers to invest more cash up front to evidence their continued commitment to projects. Consequently, loan applications for certain types of developments that were commonly approved prior to the pandemic were no longer universally accepted. For instance, projects involving land acquisitions became too risky for some lenders. Others continued to fund land acquisitions, but only if the projects were located in their primary footprint and the land was shovel ready.
Current Construction Lending Trends
By the end of 2020, the world began to accept the pandemic’s presence. The vaccine rollout had a positive effect on consumer and business confidence, which increased confidence in the economy overall. As a result, the lending industry reverted to a more normalized lending environment. Today, banks are largely healthy, and they have cash to loan. Construction lending is not without challenges, however.
The emergence of e-commerce markets and the growing acceptance of working remotely have led to decreased demand for conventional office and retail space. Though analysts predicted the shift for years, social distancing requirements accelerated its arrival. Some businesses are scrapping storefronts and in-person collaboration spaces altogether, seemingly authoring a negative construction narrative for the foreseeable future, at least in these segments. The good news, however, is that there has been a surge in demand for industrial warehouses and distribution centers. These developments typically produce the strongest rents, which make them some of the easiest projects to finance – something not lost on the lending industry.
Post-Pandemic Projections
So, what happens next? That question might as well be filed next to “When will the pandemic end?” We just can’t know for sure. What we do know is lenders must continue lending and, as always, they want to get more good loans on their books. There are business opportunities for those able and willing to adapt and embrace change, and more post-pandemic prospects appear to be on the horizon. Lenders of all sizes are still involved in a range of construction activities, and with good reason. Many lenders are reporting stable or increased growth in construction lending, and despite the early difficulties outlined above, the construction sector’s overall outlook remains strong. Experts expect the construction industry to grow faster than manufacturing and service industries, and analysts are forecasting it will be a key component of the nation’s continuing economic recovery.
Nobody can say for sure when, or even if, the world will return to pre-pandemic norms. Navigating a global pandemic is something no one alive today has experienced, and we are all learning as we go. One thing is certain, though: Lenders are looking for stability. They are aiming to reach markets with promising economic factors, and commercial construction appears to be a good place to start.
Joseph D. Palumbo is an attorney with Carmody MacDonald in St. Louis. He focuses his practice in the areas of commercial lending, real estate, business law and financial restructuring. Palumbo can be reached at jdp@carmodymacdonald.com or at 314.854.8615.
This column is for informational purposes only. Nothing herein should be considered legal advice or as creating an attorney-client relationship. The choice of a lawyer is an important decision and should not be based solely on advertisements.