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Foresight Analytics: Construction Lending to Slow Sharply in Second Half

Construction loans outstanding backed by major commercial property types continued to expand, growing to $295 billion at the end of the second quarter, according to a report from Foresight Analytics, but the pace of growth is slowing.

Based on an analysis of data from the FDIC, relating to commercial bank and thrift construction lending activity, Oakland, Calif.-based Foresight Analytics reports that construction loans outstanding backed by industrial, retail, office and hotel properties rose 5% in the second quarter of 2008, compared with the first quarter of the year.

However, the pace of growth is slowing. And Foresight Analytics expects the pace to decline further during the course of the year.

“Commercial construction — if it is not quite grinding to a halt — is getting pretty close in the credit crunch. The broader credit crunch is having an impact and making lenders more reticent to make construction loans. Also developers are more cautious as well,” says Matt Anderson, a partner with Foresight Analytics.

Foresight expects to see the growth in lending on commercial real estate projects tapering off, with essentially no growth for the second half of the year. And there could even be a decline going into 2009. This means that there are a couple of lean years ahead for developers.

Taking into account single-family construction loans as well, construction loans outstanding contracted 0.7% to $627 billion during the second quarter, the first such decline since the second quarter of 1994, according to Foresight Analytics.

Loans on construction backed by condo projects were down about 1% in the second quarter, from $ 41.3 billion outstanding at the end of the first quarter. However, construction loans backed by apartment properties continued to grow, gaining roughly 2.5% to end the second quarter to $46.6 billion.

There is more optimism among developers about the condo and apartment sectors than about the single-family residential sector, according to Anderson. Even then, condo loans outstanding have contracted since “it is more of an all-or-nothing type category.”

This means that unlike single-family communities, a developer has to complete an entire condominium project to get it ready for occupancy. In the case of a single-family community, developers could end up building only the number of units for which they have orders.

The “all or nothing” nature of condo construction has also caused delinquencies on loans backed by these projects to balloon to 16.5% at the end of the second quarter, from 4.2% at the end of the second quarter of 2007. Delinquencies had reached 13.7% at the end of the first quarter.

In the apartment sector, demand for apartments has increased as result of problems in the housing market, causing rent growth to hold steady. Indeed, delinquencies on construction loans backed by apartment properties are still at a low 2.9%, though still up from 2.4% at the end of the first quarter.

“There are some indications that rent growth is slowing down. So we wouldn’t be surprised to see construction volume in the apartment sector beginning to slow down as well,” notes Anderson.

Delinquencies on commercial-property backed construction loans stood at 4.1% at the end of the second quarter, up from 3.6% at the end of the first quarter. Even then, fundamentals are still pretty good in the sector, according to Anderson.

While vacancy rates in most product types are up across a number of markets, they are not anywhere near the post 2001 levels, following the bursting of the technology bubble and the 9/11 terrorist attacks.

Including single-family construction loans outstanding, the overall delinquency rate on construction loans stood at 8.1% at the end of the second quarter, a level not seen since 1994.

“The contrast in this cycle versus the early 1990s cycle is that most of the problems back then were in the commercial sector. It was commercial real estate that was way overbuilt, whereas this time it is residential that is way overbuilt,” says Anderson.

At the end of the day, construction lending on commercial projects is still in a relatively healthy environment. “There’s a hesitancy that is driving the general pullback. A lot of independent people are still waiting to see what happens with the general economy. We are not technically in a recession yet by most measures, but there are a lot of problems in the economy and demand has certainly slowed down,” says Anderson.

He expects that after the economy gets back on track by the end of 2009 or early 2010, and the credit crisis has eased, more financing is likely to be available. Lending on commercial property construction activity also is likely to expand at that point.

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