As a builder in this credit crunched market, you are running out of good options. Most builders who work in a small scale local marketplace rely on credit strength to see them through. In effect, building a new home in the speculative market is like having a giant credit card. You make a big purchase which is the loan you require to build the home. Then you set it up to pay interest every month until the home sells.

Banks determine the amount they are willing to loan you based on a Loan to Value relationship. This number is usually around 75%. Which means that when you submit your building plans to the appraiser, they determine a value and this value is what the banks use to decide how much to loan you.

However, when the market goes sour and your loan expires (most loans were about a year long until it must be renewed, now it is around three months) the banks then have to re-appraise your property and therefore rebalance how much they can loan you. In this market, with falling appraisal values, banks are scrambling to keep up and when they determine the new amount they can loan you, it drops right along side the new appraisal in most cases.

This causes the loan to be “out of balance” (75% of a much lower number is all they can loan you now) and it is up to the builders to put the loan back in balance. This usually comes in the form of paying on the principal to reduce the bank’s exposure. The challenge for builders is that they most likely have been working off of an interest only or interest based payment plan. If they have been carrying a home for years (usually on a wing and a prayer) and then they must pay lump sums to re-balance the loan, there becomes a problem. It would be like a homeowner paying interest for many years and then have to make payments up to 10% of the value of there home, overnight.

But the “spec” market is a four-letter word these days, but rest assured, not every spec builder was a greedy businessperson trying to ride the homebuilding wave, many try and build homes for the future of a community that are architecturally consistent with their environment or with green elements. It is not in these communities best interest that long standing local builders dissolve since in effect, it would eliminate future growth and renewal. Once the longstanding builders dry-up they may be replaced by opportunist builders who have less sensitivity to the local culture.

In defense of the banks, they are in a precarious situation, they are faced with many compliance issues and audit challenges from the new lens by which they are looked under. It will take creative solutions and teamwork to resolve these issues, but it can be done. We are planning to submit a plan for builders who are in this situation that can be both positive for the banks and the future of the builders. This will be posted in the blog in the near future.