It’s too early to tell, but banks may be starting to provide the downtown Chicago apartment market with something it could use right now: restraint.
They’re tightening lending guidelines for new developments and being more selective when picking projects to finance. With more than 6,000 apartments under construction downtown, that’s widely viewed as a good thing, a sign of a market that is functioning well.
“The market’s a little tighter,” says Chicago developer Tony Rossi Sr. “There’s a lot of product out there, and people are getting a little nervous.”
Banks are pulling back in response to tougher regulatory scrutiny and their own belief that apartment developers could use a breather. Collectively, banks have a reputation for being unable to say no to developers—see the condo bubble of 2006—but John Petrovski, head of real estate lending at BMO Harris Bank, says they are proceeding with more caution in the downtown apartment market today.
“It is a bit tougher (to get a construction loan), but that’s good news because the market was getting a little speedy, so tapping on the brakes provides good discipline,” says Petrovski, senior vice president and managing director at BMO Harris, the Chicago-based unit of BMO Financial Group in Toronto.
Banks are taking a much harder look at apartment developers and their equity partners, and they have lowered the amount of money they will lend on projects. BMO Harris used to provide a loan representing 75 percent of the cost of an apartment development, but now it will finance only 65 to 70 percent, Petrovski says. Recent projects financed by the bank include the NewCity apartment-retail development on the Near North Side and City Hyde Park on the South Side.
DEMANDING TOUGHER TERMS
Interest rates on construction loans also are rising, pushing up project costs and depressing returns, and banks are demanding tougher terms, requiring, for instance, higher reserves to cover certain costs. Those changes can add up, discouraging some developers from moving forward.
“That kind of culls out the weaker projects,” Petrovski says. “If developers are looking for loans on last year’s terms, they’d be struggling to get them.”
Wary of repeating the mistakes that led to the last real estate crash, bank regulators are talking tougher today when it comes to commercial real estate lending. The Federal Reserve and other regulators issued a statement last year expressing concern about the “rapid growth and competitive pressures” in commercial real estate lending.
Moreover, new rules under the Basel III banking accord that went into effect in January 2015 require banks to set aside more capital to cover “high-volatility commercial real estate.” One result: Banks are being more discriminating when it comes to construction loans.
Banks already have lent so much money to apartment developers in the Chicago area that they have hit allocation limits that prevent them from having too much debt concentrated in one sector in a single geographic area.
“It’s all about buckets of risk: You don’t want too much in multifamily,” says mortgage broker David Hendrickson, managing director at Chicago-based Jones Lang LaSalle. “Almost every lender is at or near capacity.”
Still, the lending slowdown isn’t apparent to the naked eye. Banks held $5.9 billion in Chicago-area construction and land loans—a figure that covers all property types—at the end of the second quarter, up from $4.7 billion a year earlier, according to research firm Trepp.
Also at the end of the second quarter, 21 apartment buildings with 6,385 units were under construction in downtown Chicago, according to Appraisal Research Counselors, a Chicago-based consulting firm.
The numbers suggest a pullback in bank lending may be coming too late to avert an apartment glut. Appraisal Research forecasts that developers will complete a record 5,000 apartments downtown next year and about 3,800 in 2018. Those numbers far outstrip a key measure of demand, absorption, which is averaging about 2,500 units a year.
Still, if there’s an oversupply, many observers expect it to be temporary. A retrenchment by banks could keep it from getting out of control.
“It shows some discipline in the market,” says Appraisal Research Vice President Ron DeVries. “We’re going to have a little of an overhang in the market, so this will keep things in check.”
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