Building a Winning Deal

By Julie Knudson

Today’s CRE market is hot, with few signs of cooling in the near term. From feeding the multifamily housing boom to building brick-and-mortar retail projects that fit consumers’ shifting shopping habits, construction loans are an increasingly attractive sector for community banks. But it takes market know-how and some careful strategy to attract the best customers.

Know your market

Fierce competition is making the commercial construction sector a tough one for many banks. Other loans that used to be part of an institution’s portfolio—autos, furniture and the like—have largely moved to other markets. “All that business has gone away and many banks today are chasing construction loans,” says Phil Goncalves, SVP at Country Bank, based in Ware, Mass. Seeking to fill the gap, banks that didn’t historically focus on the CRE space now see it as ripe for the picking. And even though construction lending often carries more risk, Goncalves says, “Every deal now becomes that much more important.”

While the number of banks jockeying to be first in line in the booming construction business continues to rise, providers are popping in from other sectors, too. “We’re also competing with nonbank lenders that are doing nonrecourse deals,” says Lauren Jarrell, SVP at Triumph Bank in Memphis, Tenn. “It’s finding a balance between price, guarantee structure, equity—just making sure all the pieces fit together yet still being competitive.” Because developers and contractors are often under a time crunch to get started, banks need to know what fits their market so they can connect those dots quickly.

The construction marketplace itself is creating additional challenges for lenders and customers alike. “Material costs such as lumber keep rising, whether it’s a tariff scare, fires or other reasons,” explains Roger Shumway, EVP and chief credit officer at Ogden-based Bank of Utah. It’s also difficult to find labor in many regions, and contractors don’t always know what their workforce costs might be, even in the near term. Not only do these factors result in projects that may take longer to build, but Shumway adds, “contractors also don’t want to enter into fixed price contracts.” Lacking good insight on where expenditure levels will fall and when they’ll be able to complete their project, borrowers are increasingly selective about their loan terms.

Find the opportunities

When it comes to reaping success in the construction lending sector, service is a top priority. “Everything else becomes secondary if you can service them,” Goncalves says of borrowers. Savvy customers don’t want to call a 1-800 number only to spend time wading through menus and automated prompts. “They want to speak to a person, an actual lender,” Goncalves says. He sees this trend as a plus for community banks, which specialize in high-touch customer relationships. “It matters to pick up the phone and return a call that day,” Goncalves says. If it isn’t possible to connect with the customer right away, he suggests sending them a short e-mail promising a speedy follow up. Knowing that good customers are being wooed from all directions, responsiveness can go a long way toward cementing a solid relationship.

Excellent service up front and a commitment to maintaining those high standards throughout the process help attract developers and other borrowers, particularly those with experience weathering the marketplace’s ups and downs. “I have customers that know I’m not the cheapest, but they aren’t necessarily looking for the cheapest,” Jarrell says. Instead, customers choose banks they can count on in the days ahead. “They want someone who can do what they say they’re going to do,” she says.

Though the banking industry has experienced a lot of change in recent years, never underestimate the importance of long-term consistency. Shumway says Bank of Utah doesn’t exit markets, so potential borrowers know they’ll be a steady presence for future projects. It creates a stable platform for ongoing relationships. “We’ve been good at not surprising borrowers with any changes at the closing table,” Shumway says. “What we say we’re going to do is exactly what they get.” Experienced CRE borrowers quickly grow leery of lenders who change direction mid-stream, and they’re likely to look elsewhere for their next loan.

In the commercial developer space, the more sophisticated and experienced the customers are, the better it is for the bank. These borrowers have been doing projects for a while and they know how things work. For them, the ease of doing business is a high priority. “Commercial borrowers will move to lenders if it’s easier, even if the rate is a little higher,” says Chris Boyd, VP of product at Built Technologies in Nashville, which was recently endorsed by ABA for construction loan management software. “To get some of those great deals and to work on the best projects, banks have to appeal to those sophisticated groups.” Many forward-looking community banks are differentiating themselves from their competitors by adopting new technologies that help them boost customer service, ensure fast response times and streamline administrative tasks.

Making the deal today

Though rates are still important, banks are changing their construction loan structures to stay competitive. Guarantees are going away in some instances and terms are being extended. “Before, it would be interest-only for a year,” Goncalves says. “Today we’re seeing maybe three years of interest-only as a normal term.” When lenders know their institution’s philosophy on what kind of CRE deals they want to support, they’re able to get a commitment into borrower’s hands before someone else does.

Ideally, the principal guarantees the loan 100 percent through construction. “We like them to be all-in with us at the beginning of the deal, because we’ve found if they’re not, they’ll just pay us off with a permanent loan,” Jarrell says. Other structures may be an option, though. “We’ve tried to find a compromise with borrowers,” she explains, adding that step-downs and reduced guarantees can sometimes create the right solution for the customer. “If we want to keep the loan we’ve got to give a little bit,” Jarrell says of the competitive environment.

Making loans attractive to borrowers includes improving their experience more broadly. Just as consumers are accustomed to accessing their accounts from their mobile devices anytime, anywhere, business customers want to access the same tools. “Across the board, all of our expectations have risen around what it looks like to have a banking relationship,” Boyd says. Borrowers no longer want to call once a week to ask when they can do their next draw. Instead, they expect their bank to provide much of that data online and pair it with a frictionless way to request inspections and take care of other tasks.

For their part, banks need a good method for gathering and analyzing loan and borrower data. “By vetting customers, even a little bit, banks can do a lot to protect themselves,” Boyd explains. Technology helps to address customers’ expectations while also giving institutions an efficient platform to maintain a strong paper trail. “Every time they manage a project, they can glean information to help mitigate risks on future projects,” Boyd says. As that internal database grows, it can be used to assess past project performance and conduct good due diligence on borrowers. This enables the bank to continue honing its success in the CRE construction market.

Julie Knudson is a frequent ABA Banking Journal contributor.