Private credit is exploding, and demand is surging. As institutional investors seek upsized returns, more funds geared to homebuilders and residential land developers are popping up with abundant capital to deploy. And why not? Excellent lending opportunities exist with experienced builders in great locations constrained by their community or regional banks. While demand for new housing is excellent and the future is optimistic, banks are bogged down by regulation, extreme caution, and legacy commercial real estate issues.  

Although still evolving, the private credit industry has become an investment darling with capital pouring into these funds. Per data firm Preqin, the overall private credit market had approximately $1.7 trillion of assets under management globally as of June 2023, up from around $500 billion at the end of 2015. BlackRock estimates that continued large shifts in borrowers seeking private credit will boost the value to $3.5 trillion by 2028.

In today’s restrictive lending environment, homebuilders are fortunate to have private credit as an option. It’s a golden opportunity for these non-regulated funds as well as exciting growth capital for builders. If this newer stream of capital wasn’t available, the housing shortage would be prolonged, with affordability even more at risk. These funds are positively contributing to the industry by providing growth capital that was historically unavailable. 

Not A Commodity

With the influx of capital, are these debt funds becoming a commodity? Absolutely not. My experience finds large differentiators relating to business models, goals, culture, and, most importantly, people. Add streamlined processes, integrity, transparency, and certainty of execution to the list.

The ability to add value plays a huge role. Some funds have partners and managers who were former homebuilders or real estate investment bankers and add tremendous value regarding structure, capital efficiencies and contract negotiations. You work with fund owners, partners, and loan committee participants. The good ones can become valuable capital partners by providing innovative structures and flexibility that benefit all. Many have a vested interest in their funds and go above and beyond for their borrowers. Some sell their loans in the secondary market, while others keep them on their balance sheet.  Some use back-leverage, others don’t. The good ones can attract and retain top talent, which is competitive today.

Specialization and Flexibility

With private credit in homebuilding you get access to specialized funds with different lending models. These include land acquisition, development, and construction funds (AD&C), A&D funds, A&C funds, D&C funds, and C funds. There are senior debt funds, mezzanine debt funds, preferred equity funds and land banking funds. Non-recourse, limited recourse, and recourse. Permanent financing funds, bridge funds, and bridge to permanent funds. Higher leverage for higher cost and lower leverage for lower cost. Build-for-sale funds, build-to-rent funds, and funds that finance both. Some will lend nationally, while others focus regionally or are state-specific. Loan amounts also vary. Some want to lend over $10 million per project, while others prefer loans under $10 million. Some target loans over $20 million, while others focus over $40 million. They all have preferred “sweet spots.” There are megafunds with large organizations and boutique funds with a few managers. Organizational size doesn’t always determine capability, as I work with some smaller firms with very deep pockets and a national reach.

Flexibility is the key, and builders benefit from it. Private credit provides a real boost, especially for midsize private builders, allowing them to bring their projects to fruition and compete with big builders. This access allows them to flex their muscle and display their expertise and impressive products. It provides them with excellent financing options and can level the playing field.  

The cost of capital is higher than banks, but higher loan-to-cost/loan-to-value makes the blended rate competitive, as less equity is needed. Plus, you can get more capacity for a single borrower with no deposits or additional collateral required. I’m seeing pricing compress slightly as funds compete.

Underwriting has remained disciplined, as many fund managers have experienced downturns. Although they are required to deploy capital, they can be creative to make the deal work while keeping risk levels appropriate for themselves and investors. A few things to keep an eye on include maintaining appropriate underwriting standards, speculative lending potential, other real estate asset classes or industries some funds may be involved with, and the fact that private credit generally has not been cycle-tested.

Builders Deliver

Investors see an opportunity in private credit geared toward homebuilders, especially with today’s favorable demographics and housing shortage. The returns generated have been very good, with defaults below historical averages. It provides a lifeline and immense opportunities for builders dealing with restrictive lending. 

A Q1 2024 survey from NAHB states:

After nine consecutive quarters of tightening, credit has now unquestionably become difficult for most builders and developers to obtain, irrespective of how much additional tightening lenders applied in Q1.”

In response, private credit has stepped up, offering specialization, flexible terms, and quicker approvals. Builders are doing their part by meeting return expectations while proving to be smart, reliable borrowers. The synergy between private credit and today’s urgent housing needs is reshaping the landscape, enabling builders to capitalize on the robust demand and contribute to easing the nation's housing crunch.