Strategies for Community Bank Construction Lending

Community banks take on a large amount of risk when it comes to construction lending, especially in the current market as lenders, builders and developers are grappling with tightened credit conditions and rising interest rates.

However, after the recent string of rate hikes and cooling inflation, most Fed officials only see one or two more smaller rate hikes in the future. As a result, some sectors will see upward momentum for new project funding while others may continue to see signs of distress.

Banks are monitoring portfolios and focusing on specific loan types or submarkets for growth opportunities. At the same time, banks are also monitoring for signs of distress in other areas.  

By conducting thorough due diligence, applying the proper strategies and connecting with their customers, banks can make profitable construction loans while also reducing risk.

Where are the growth opportunities?

While banks are taking a more critical look at construction loan applications before approving any funds, there are areas of the construction industry that are continuing to show solid growth, including digital infrastructure, cellular systems and data centers, healthcare, and low- to moderate-income multifamily housing.

A recent International Banker article pointed out that  U.S. Census Bureau figures on construction spending in December 2022 show that outlays on multifamily projects climbed by a seasonally adjusted 3% from November and by 21% from December 2021.

More opportunities are on the horizon.  The largest gains in manufacturing construction are likely to come from plants to build electric vehicles (EVs) and their batteries and other components, many of which were announced last year. These plants cost several billion dollars each and are planned or underway in numerous southern and midwestern states.

This is part of a broader trend where investments in environmentally-friendly and sustainable design are increasingly attractive. Lenders are becoming more willing to provide financing for projects that prioritize energy efficiency, water conservation, and other sustainable features.

Additionally, many of the projects funded in part by the Infrastructure Investment and Jobs Act (IIJA) have yet to start.

Getting Ahead of Risks

However, just as there are opportunities for construction lending, there are risks to be aware of as well, so thorough, ongoing monitoring is essential. Having a pulse on your construction portfolio means measuring what’s happening in as close to real-time as possible so that you can effectively manage and improve portfolio performance. In the past, this has meant man hours, paper files, flurries of email threads and spreadsheets.

Thankfully, those cumbersome processes can be replaced with digital processes that enable you to more closely monitor a higher volume of loans with greater precision. Today, you can proactively mitigate risk with a clear understanding of your portfolio exposure and the status of all active construction projects in real-time with the latest tech.

For instance, lenders can use modern loan origination and portfolio risk monitoring tools to keep all projects are completed on time, on budget and without misappropriation of funds. This also keeps all stakeholders informed on change orders, draws and other details. Additionally, the right tools ensures all policies, procedures and documents exceptions are tracked and recorded for regulatory purposes.

Technology Lends a Helping Hand

Construction loan risk is often magnified on larger-dollar multifamily and commercial real estate construction loans. In addition to underwriting the borrower and/or developer or general contractor doing the work and project feasibility, lenders providing loans to commercial real estate and apartment developers are paying close attention to local market conditions and how different property sectors are performing.

The good news is construction lending can offer opportunities for excellent returns, if you take the appropriate measures to execute on the right deals with speed and accuracy while mitigating any potential risk. This is where today’s technology can lend a helping hand.

Author Bio

Baker Hill empowers progressive financial institutions to increase revenue, reduce risk, and drive more profitable relationships.

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