Length of the Twin Cities apartment boom to be decided by banks

People who look at all the cranes around for even more apartment projects and ask what the developers could be thinking don't quite understand the way the real estate market works.

What happens next in the apartment market isn't really up to the real estate developers, it's up to the bankers. The apartment building boom in the Twin Cities will end when enough loan underwriters and chief credit officers say it should.

In all capital-intensive and cyclical businesses, the people who decide whether the market needs another project are the people who control the money. It's kind of funny, in a way, that it's the real estate developers who are always characterized as our economy's classic risk-takers.

The best way to think about real estate finance is that the owners of any conventionally debt financed building, with their equity contribution, don't really own anything but the option to buy the building from the lender, by making their scheduled loan payments.

As for the bank, well, from the date the construction loan deal closes the bank is all in. And if everybody on the project team then goes golfing on a brilliantly sunny summer day to celebrate, it's the bankers who will be carrying the big umbrellas.

After checking the pulse of the market with mortgage bankers and others in the last week, no one is really predicting stormy weather anytime soon in this apartment lending market. By one count, that of the well-known firm Marquette Advisors, nearly 4,000 additional units in more than two-dozen projects will open in the Twin Cities this year. New projects, like one in Edina on a former Best Buy store site, keep surfacing, too.

On the other hand, lenders have been "tapping on the brakes" this year, making new loan money a little more difficult to obtain.

It is true that there was an uptick in the vacancy rate from 2015, but apartment owners consider 3 percent vacancy to basically be full. The market is considered to be balanced with a 5 percent vacancy rate. There also remains a strong case to be made for a continuing housing shortfall here in the Twin Cities, as young people snag a good job and move out to establish their own households.

So why have lenders become a little more cautious? The financiers shrug and say, in effect, that all real estate markets move in cycles from boom to bust. A strong growth cycle has been going already for several years.

That nothing-lasts-forever thinking was all over a notice federal regulators put out at the end of last year, written in the officious language of regulatory authorities. It advised bankers (and the public) that the real estate market sure has seemed pretty strong, real estate loans have grown a lot, and so in 2016 the bank examiners were going to be coming around to make sure bankers haven't lost their heads.

So the bankers of late have been asking for more equity to be put in a deal, meaning that the banks are still going to come up with by far most of the money for a new project, just not as much of it as they had a year ago. They may also be demanding more security for the loan, like a personal guarantee, and that does make the developer a risk-taker.

In addition to making the owners put up more cash equity, the banker has a number of other levers to pull to reduce risk.

Once "stabilized," more or less full of renters paying their rent and creating positive cash flow, it's common for a construction loan to switch from interest only to what's called a "mini perm," a relatively short-term mortgage that requires a borrower to start making principal payments, too. So another way for a banker to tap on the brakes is shortening the amortization period, maybe from 25 years to 20, used to calculate the payments during that so-called mini perm period.

This kind of loan term revision may seem like no big deal, just a few more dollars going out at the start of the month. But it has the effect of raising the economic bar for the project to cross, because now there has to be sufficient cash flow to make a bigger payment. It could be enough to keep a project from getting built.

Having a committed pessimist on any bank's loan approval committee probably seems like a good idea, given the risks involved, yet being the most cautious bank in the market during the period of strong loan growth isn't the way to capture market share.

That may explain why one mortgage banker last week said any developer with a solid track record could expect five or six proposals for financing, on terms more or less in line with one another. And when I reached Mary Bujold of Maxfield Research, a real estate market research and consulting firm often hired by developers and their lenders, about the only discouraging note she sounded in our conversation is that business for her firm has been so brisk she hasn't had quite enough time this summer to enjoy the warm weather.