Higher Rents, Home Prices Predicted : S&L; Bailout Bill Is the Culprit, Loan Officials Say

A sharp reduction in the development of new apartments will probably be the most immediate effect of the savings-and-loan bailout bill approaching passage in Congress. But the more lasting and broadly felt result could be to make mortgage loans and single-family houses more expensive.

So say executives at Home Federal Savings and Great American Bank, two San Diego-based S&Ls; that are heavily involved in real estate development as well as lending, principally in San Diego County. The executives praised the $166-billion S&L; rescue bill as long overdue but warned that its consequences would generally not be happy ones for housing consumers.

Both Roger Lindland, president of Great American Bank, and Jack Roach, chief operating officer of Home Federal’s development arm, said they will cut their apartment lending activities because new risk-based capital requirements in the bailout bill will make the loans less profitable. And they expect others in the industry to follow suit.

Fewer new apartment projects, in a market such as San Diego where an ever-increasing population is finding housing increasingly unaffordable, translates into a higher demand-supply imbalance and therefore higher rents “down the road,” Roach said.

Moreover, both executives predicted in interviews that the bill’s disincentives for S&L; development activities will eventually cut the supply of housing and mortgage money, reductions that will increase housing costs.

Generally speaking, housing finance will become more scarce once the S&L; shakeout is complete, simply because the consolidation of the S&L; industry will leave fewer loan sources for consumers and less competition, Lindland said.

Although the $166-billion bailout bill has not yet been passed into law, observers expect the version hammered out by House and Senate negotiators last week to stay largely intact. That version imposes strict new capital requirements that force S&Ls; to have much more cash equity on hand to cushion the government from liability for riskier loans.

The new bill also assigns tougher capital requirements for certain kinds of loans. For example, the new bill classifies apartment loans in the riskier commercial loan category, which means lenders will have to keep as much cash equity set aside--up to $8 for each $100 loaned--as it would for an office or retail building.

The new provision dims the appeal of apartment lending considerably, Roach said, because the higher capital requirement will reduce the S&L;’s rate of return. In the past, S&Ls; could make apartment loans as long as the S&L; had the regulatory minimum of 3% equity as a percentage of assets.

Even if the S&Ls; choose to set aside the added capital for apartment loans, they will be more restricted in how much of their loan portfolios are devoted to apartment loans. In the past, apartment loans were lumped together in the home mortgage loan category, which under old rules could constitute up to 60% of an S&L;’s loan portfolio.

In effect, S&Ls; could make up to 60% of their loans to apartment developers as long they met the 3% minimum regulatory capital requirement.

Now, with apartments reclassified as commercial loans, S&Ls; will be permitted to have only 30% of their loans in commercial projects including apartments, with 70% in single-family residential loans or residential mortgage securities. The lower apartment loan ratio, coupled with higher capital requirements, will translate into higher apartment development costs.

Will Force Change

Roach said the bill is designed to either force S&Ls; out of real estate development altogether or to force them to set up stand-alone subsidiaries over a five-year period. The subsidiaries will constitute a “fire wall” between development activities and government liability for insured S&L; deposits that in the past were used to finance development, Roach said.

Most S&Ls; are expected to get out of real estate development altogether because they will need all the cash capital they can muster to meet new and tougher equity standards by 1994. Most S&Ls; will have little money left over with which to capitalize the new development subsidiaries, Roach said.

Furthermore, the new rules will prohibit the development operations from borrowing low-cost loans from the sister S&Ls;, forcing the S&L; development arm to compete on an “even playing field” with other developers for outside debt capital, said Stan Ross, co-managing partner of Kenneth Leventhal & Co., a Los Angeles-based accountancy and consulting firm.

Despite the disincentives, both Great American and Home Federal say they expect to remain active in real estate development, probably through subsidiaries. Home Federal in fact expects to form a new subsidiary within the next 30 days, perhaps using $50 million available in its HomeFed Corp. parent company for the initial capitalization.

Home Fed is an acknowledged leader among S&Ls; in real estate development, according to analyst Gary Gordon of PaineWebber in New York. Home Fed’s net real estate development profit of $31 million in 1988 represented 28% of its net income last year. Home Fed now has about $200 million in equity invested in lots, apartments and houses.

Home Fed is confident it can attract equity partners and borrow sufficient funds to keep its real estate development activities profitable under the new rules, although probably not as profitable as in the past, Roach said.

Home Fed also has the luxury of having a surplus of capital relative to most other S&Ls;, a surplus that it will be able to allocate to the new real estate development entity if it so chooses. For example, Home Fed’s tangible net worth, or shareholder equity minus good will, is now 4.9% of assets, far above the 3% minimum it will be required to have on hand by 1994.

Great American’s tangible net worth, by comparison, is now 2.6% of assets, meaning it will have to have to devote more resources to meeting minimum capital requirements than Home Fed over the next five years. Lindland said Monday that Great American is in no hurry to set up its development entity, adding that it will be accomplished over the next three years.

Great American’s profit from real estate development activities last year was $26.1 million, more than half of its $49.4-million net income.