Pension funds provide a partial boost for builders.

Real estate rebound requires infusion of millions of dollars

The California Public Employees Retirement System is cutting a deal to provide up to $250 million in construction financing for new homes, but builders must find billions more if their industry is to rebound this year.

At the same time, the Southern California Building Industry Association hopes to finalize commitments with East Coast pension funds to form a similar $125 million pool, although late word from the negotiations is that this may rise to $300 million. The funds will be lent exclusively to BIA members so they can buy land and finance construction.

Both funds were formed to ease a two-year construction financing shortage that has slowed Southern California's once feverish housing industry. The shortage came about in 1989 when banking regulators started looking more closely at the value of the real estate that was pledged as security on billions of dollars in loans. They found the market had cooled and that prices were dropping. As a result, some of the property was not worth what was owed against it. Since then, builders have frantically been scouring the country -- the globe -- for money.

Until the CalPERS offer, they have had little success. TRW REDI Property Data, Riverside, shows construction mortgages recorded in Los Angeles County dropped to 1,706 worth a total of $1.9 billion in the first 10 months of 1991 from 3,455 worth $4.82 billion a year earlier. It will take a lot more than the CalPERS $250 million to make up for the $2.92 billion drop in construction financing.

If new capital pools can be filled, the financing drought will be partially broken. If they stay dry, California's construction employment may wither further.

The tough bank-lending rules in part made Los Angeles County's construction volume fall 11 percent, to $7.23 billion for the first 11 months of 1990 from $8.08 billion a year earlier. The drop was monitored by the F.W. Dodge Division of McGraw-Hill Inc., New York. Dodge reported construction volume for the first 11 months of 1991 dropped 34 percent, to $4.81 billion from $7.23 billion the previous year. Lower demand for office and other commercial buildings partially explains the slump.

Ironically, banks and brokers have plenty of mortgage money. But federal regulators don't want them writing checks to builders so they can buy lumber and bricks. As a result, builders with access to huge lines of corporate credit like Pardee Construction Co. and Kaufman & Broad Inc. are building the new entry-level homes.

Data supplied to the Los Angeles Business Journal in response to a 1991 survey shows Kaufman & Broad's sales climbed to $1.4 billion in 1991 from $1.27 billion the year before. Pardee's rose to $342.8 million in 1991 from $276 million in 1990.

By contrast, small and midsized builders have to spend their own money on land, building materials and labor. As a result they build fewer homes and can't take advantage of bulk purchase price breaks and labor savings associated with larger phases.

"Construction financing has all but dried up and the merger of Bank of America and Security Pacific will have a negative effect on the situation," said Marion Kiesling, vice president of sales and marketing for Calabasas-based Griffin Homes.

The financing crunch has forced Griffin to cut its volume. The firm is working with private investors to buy and subdivide land but is constantly searching for construction financing. It predicts 1991 sales at $120 million compared to $228 million in 1990.

Banking experts offer no consolation.

"Banks' attitudes toward construction lending are signs of the times. The federal regulators are on their backs especially when it comes to anything that is secured by real estate," said Chris Chenoweth. He is the senior vice president/general counsel for the San Francisco-based California Bankers Association Inc.

"Everyone hopes there will be some return toward normal conditions by 1993, maybe by the end of 1992, but nobody knows when it will actually happen," Chenoweth said.

The financing crunch already has eliminated Los Angeles County jobs. Data compiled by the Construction Industry Research Board shows Los Angeles County construction employment dropped to 149,900 in November 1991 from 160,900 a year earlier. Workers who build homes were laid off more frequently than those who work on commercial and public works projects, said Ben Bartolotto, research director for the Burbank-based CIRB.

The situation may already have worsened. Bartolotto said there is at least a six-month lag in the reporting method. Consequently, the actual number of Los Angeles County construction jobs lost could already have grown.

"There will be more declines in employment before you see a turnaround," Bartolotto said.

Ironically, the building trade unions aren't making matters better. Though they would benefit directly from providing construction financing for homebuilders, construction unions and trade organizations aren't following the CalPERS lead.

Southern California Pipe Trades pension fund trustee Milt Johnson said the $450 million fund has been reluctant to make real estate loans. The fund has made 10- and 15-year loans on apartment buildings in the past.

"The trustees might take a look at a proposal to provide construction financing for a homebuilder. But our trustees would take an extensive look at the credit worthiness of the individual and the amount of equity they had in the project," Johnson said.

Los Angeles Carpenters Union pension fund advisor Gary Morris said he wouldn't provide any construction financing.

The building trade unions' deafness to the call for construction financing is one of several ironies associated with the decline of California's homebuilding industry. In fact, homebuilders' construction financing quest is a textbook Catch 22.

Low interest rates have made housing more affordable. As a result, buyers once again are shopping for new homes. But the government restrictions keep lenders from making construction loans. Consequently, the number of new homes being built has dropped.

Encino-based Meyers Group manager Steve Smiley said scarce construction financing already has cut the new-home supply. The Meyers Group conducts real estate-oriented market research for homebuilders.

During third-quarter 1990, builders recorded 2,198 sales and had 7,037 unsold new homes. At that sales rate, Los Angeles County had a nine-month inventory of new homes.

Meyers data shows that during third quarter 1991, Los Angeles County homebuilders collectively sold 2,284 units and watched their unsold inventory drop to 5,313 homes. At that rate, it will take just six months to sell the new-home inventory.

"The inventory will probably decrease another 25 to 30 percent in the next three months. By the end of 1992, Los Angeles County will have a new-housing shortage," Smiley said.

A continued drop in construction financing and new-home building could increase interest in the resale market.

Existing-home sales also are picking up. California Association of Realtors spokeswoman Lotus Lou said at the November 1991 annualized rate of sales, 389,640 homes, it would take 15.5 months to deplete California's unsold inventory of existing homes. That compares to an annualized sales rate of 391,290, a 14.1 month unsold inventory in November 1990, Lou said.

Besides pension funds, builders also are looking at limited partnerships and real estate investment trusts for construction financing. Each investment/financing structure has separate requirements and dangers for the investor and borrower.

Real estate investment trusts raise pools of cash by selling shares. The proceeds from the offerings are used to buy apartments, offices, shopping centers and other income properties. Mortgage REITS raise funds for long-term mortgages. There is some debate whether they can be used for construction financing.

For the immediate future, REITs won't be a major factor in residential construction financing. According to Dean Witter Reynolds REIT analyst Gregory Whyte, federal regulations keep REITs from lending money on a short-term basis.

"Equity REITs aren't allowed to put money into construction financing. Mortgage REITs may be in a position to offer some type of construction financing but I'm not sure mortgage REIT managers would . . .," Whyte said.

The construction financing shortage is as much a function of competition as it is strict regulation. For now, global funds and tax-exempt funds still yield investors 9.5 to 11 percent, said Larry Roberts. He is the branch manager of Titan Value Equities Brentwood office.

"Through either real estate investment trusts or limited partnerships, there is a big growth potential in raising construction financing for homebuilders," Roberts said. Some high-income professionals with investment portfolios exceeding $150,000 are placing 30 to 35 percent of their assets in short-term construction loan pools, Roberts said.

"The REIT is still the least popular investment vehicle because of its past bad publicity. You really have to investigate the general partner, the guy who has the power to write a check with your money," Roberts said.

In years past, REITs were formed and the individuals who administered them bought bad investments and took out large management fees. In order to avoid similar traps, sophisticated investors with healthy bank accounts are participating in limited partnerships that raise construction financing money.

Jim Senechal, vice president of Temecula-based Rancon Financial Corp., has put together partnerships that have financed large communities in Riverside County. Rancon Financial raised $100 million from 15,000 investors to finance development of the 1,200-acre Menefee Ranch.

Nevertheless, small investors won't provide a permanent solution for the construction financing shortage.

"I think the construction financing for builders of entry and lower-income housing will come from the big pension funds. When the insurance industry gets over the scare of investing in real estate, they'll come back and provide construction financing," Rancon's Senechal said.

A construction financing limited partnership or REIT might have problems matching the return rates of a well-managed fund. Senechal claims Rancon's $100 million investment pool has provided investors with a 15 percent to 16 percent annualized rate of return on equity.

TMP Capital Corp., an Orange County mortgage company, provides construction financing for Orange County homebuilders through limited and general partnerships.

TMP charges the borrower (the homebuilder) a healthy origination fee -- as much as 13 percent of the loan amount -- and a short-term interest rate of 15 percent.

Unfortunately, the unsophisticated investor seeking a haven more lucrative for his savings than a 4-percent money market account may fall prey to unscrupulous promoters. Investors are lured by the promise of a safe, real-estate-secured investment. But unless they diligently investigate the track record of the general partner offering the investment, their investment may get wiped out, said Tony Thompson, president of the Newport Beach-based firm.