And then there are the one-off events that defy the cycle. The pandemic, for instance, created the ground for a huge boom in renovation, Joseph Weissglass, managing director at investment bank Configure Partners, told 9fin.

“If you look at most of those businesses, you’re tasked with teasing out the Covid impact versus what's truly sustainable in the financial performance,” Weissglass said.

But things appear to have normalized since then in the homebuilding sector and it has settled back into its cyclical ways. Complexity still exists Salman Mukhtar, head of execution at Corinthia Global Management, said. That means some lenders are still cautious despite the recent spike in activity.

“Maybe it's still not behind us, but last year was absolutely a risk,” Mukhtar said. “You had a hockey stick pickup in EBITDA in some of these businesses, so you really have to get comfortable with the sustainability of performance ramp.”

Building a foundation

Private credit’s stable model of financing — the certainty of execution, the small group of lenders, ability to tailor financing according to whatever the needs of the owners — is an attractive one for sponsors who will seek to grow a cyclical company through the good times and the difficult ones.

“Private credit has played an outsized role in these more cyclical, or perceived as cyclical, type industries,” Weissglass said.

But those benefits for sponsors come at a price, typically higher than other industries, such as healthcare, technology, and business services that private credit firms favor.

“Home improvement businesses servicing new construction or [the] deferrable renovation segment tend to get financed at a premium and lower leverage due to performance volatility,” Mukhtar said.

Let’s look at the two recent deals. Great Day Improvement’s loan was priced at SOFR+550bps and Nations Roof at SOFR+525. In recent months, larger deals in Great Day’s range had regularly priced with 4-handles. Smaller deals like Nations Roof were often pricing at SOFR+500bps flat.

The other way lenders can insulate themselves from the whims of homebuilding credits is where it marks the leverage. As deals get more competitive across private credit, leverage reads have been climbing, but in homebuilding they’re remaining pretty tight.

Take Great Day’s loan. The LTV on the business only came in around 30%, lower than is typical in today’s market across other sectors.

Low leverage for these types of deals is fairly usual, Tim Warrick, managing director at Principal Alternative Credit said. Low leverage combined with a strong covenant is what can help private lenders get comfortable with homebuilding.

“Probably starting at 30 to 35% loan to value with covenants would be something that could be a reasonable structure,” Warrick said.

Two covenants that will appear often in these deals are net debt to EBITDA and fixed charge coverage tests. “Lenders are going to want early warning,” Configure’s Weissglass said.

Home loaner

The homebuilding sector also encompasses a service sector that provides that a lot of opportunities to private credit. For as any homeowner knows there is a constant deterioration that is needed to battle against — some situations you can stave off and others that require immediate attention.

It can be as simple what you need to have versus what is nice to have. A distinction private credit lenders firmly understand.

“In home improvement, it's crucial to differentiate between businesses offering essential, non-deferrable services and those tied to new construction or optional projects,” Mukhtar said.

Non-deferrable services include roofing, should it cave in; heaters, should they go cold; or air conditioners, should they break down. (See 9fin’s previous coverage of the HVAC sector and why private credit is a big fan.)

For new construction-linked businesses, the market can’t agree. Businesses that rely on new construction are seeing some lenders pass on the opportunities, opening up a space for others to seize on the opportunities as the landscape becomes less competitive.

“I’d say there’s a general perception that if you're buying into new construction related concepts right now, you're closer to a trough than you are a peak,” Weissglass said. “There's a developing comfort amongst investors that you can underwrite current financial performance, and if anything, it should trend up.”

That’s at least the view in the leveraged loan market, where the homebuilding market is beginning to crawl out of its current difficulties, betting on interest rates coming down that may fuel the growth of the sector — 9fin reported last week.

However, for some, there is less enthusiasm for new construction. But where there’s disagreement, there can be an opportunity for winners — albeit at a risk.

“If it's a significant amount of new construction exposure, especially where we're at in this cycle, with new home inventory moving to higher levels at this time, we would likely pass on the transaction,” Principal’s Warrick said.

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