Pennies From Heaven For Homebuilders

It was an all-too-familiar scenario. Richard J. Rabil, president of homebuilder Van Metre Cos. in Burke, Va., was ready to scoop up 220 acres in nearby Fairfax at the bargain price of $4.5 million. His plan: build 44 homes that would sell for a minimum of $400,000 apiece. But the deal began to fall apart when the bank selling the property wouldn't lend Van Metre the money it needed to close the deal. Within days, however, Rabil was back on track. Heller Financial Inc., a Chicago finance company, agreed to put up the money and become equity partners with Van Metre. "We tried to bring in institutions like Heller in the 1980s," says Rabil, "but they just weren't interested."

Times certainly have changed. Badly burned by disastrous real estate forays during the 1980s, banks and thrifts remain stingy with the money they'll commit to residential construction lending. But homebuilders are rapidly finding new sources of institutional money willing to take a chance on a comeback in the long-moribund housing market. Like Heller, which first began seeking partnerships with homebuilders in 1991, an increasing number of institutions--insur-ance companies, "vulture" investors, and pension funds--are fast becoming infatuated with the prospect of potentially high returns in residential real estate.

It's easy to see why the smart money is enthusiastic. Record low mortgage rates and depressed home prices in many parts of the country are luring hordes of buyers. "The pent-up demand, especially for entry-level housing, is phenomenal," says John S. Long, a real estate investor in El Segundo, Calif., who started his own homebuilding operation in January. So far this year, existing home sales are running at an annualized rate of 3.8 million, the best year since 1979, according to the National Association of Realtors. Despite that strength, banks and thrifts that often funded the entire cost of residential development projects in the '80s now require builders to put up 35% or more in equity for a project. And many, burned by soured loans on raw land, refuse to lend at all for land development, the high-risk phase in a project when the streets and sewers are put in.

Nontraditional money sources feel the rewards are well worth the risks. "There is a gigantic arbitrage opportunity here," says Tom Barrack Jr., chairman of Colony Advisors in Los Angeles. Barrack, who invests money for institutions such as Merrill Lynch & Co. and Cargill Financial Inc., made his first move into the residential market last spring. He bought $470 million in performing and nonperforming loans from Resolution Trust Corp., backed largely by residential lots. Within the next 12 months, he expects to spend an additional $300 million buying residential land from banks and insurers and joint-venturing with builders to develop it. Goldman, Sachs & Co.'s $1 billion Whitehall Real Estate Investment Fund is looking at similar deals and investments in existing homebuilders, says Vice-President Barry A. Sholem.

TRICKY ODDS. Pension funds are also getting into the game. At the California Public Employees' Retirement System, which has committed $300 million over the past year to residential projects in California, chief investment officer DeWitt F. Bowman says the fund is on target to earn 20% annually on those investments. Prudential Home Building Inves- tors Inc., a subsidiary of the insurance giant, expects this month to close a $100 million fund, with three-quarters of that from pension funds. The money will be used as equity in joint ventures with small and midsize homebuilders across the country, many of whom don't have the easy access to capital enjoyed by the large, publicly held homebuilding corporations.

To be sure, the rush into residential real estate carries serious risks. For one thing, if banks step up their lending to homebuilders, profit margins may ebb. The new band of true believers, though, is unfazed by such scenarios. "We're providing capital in an illiquid market," says Frank J. Zaccanelli, executive vice-president of Hillwood Development Co., a land-development company headed by Texas investor Ross Perot Jr., which is making its first plunge into homebuilding. To cash-starved builders, that's an increasingly familiar--and reassuring--refrain.

      TRADITIONAL LENDERS HAVE GONE Bank lending remains tight, particularly for 
      development of land
      HOME PRICES HAVE BEEN DECLINING Low home values in most regions, combined with 
      lower interest rates, have buyers clamoring
      PROFITS ARE HUGE Investors in homebuilding are now boasting returns exceeding 
      20% a year