Speaking at an industry forum held last week in Boston, Anglo-Irish Bank’s North American division President and CEO David K. Drumm predicted commercial real estate activity will remain slow at least through the first half of 2003.
The program title was “Real Estate Lending: Fourth Quarter and Beyond,” but the message from last Tuesday’s event at Boston’s Rowes Wharf indicated that the operative term is “beyond.” Although there are signs that the economy is on the mend, panelists warned that a full recovery is not anticipated before next year and predicted the commercial real estate industry will be among the last sectors lifted by the rising tide.
“We won’t see much change in commercial real estate until 2004,” said panelist Susan M. Wolkoff, president of Boston’s Real Estate Finance Association. “”We are a lagging [industry], so I don’t think 2003 will see much improvement for us.”
Colleagues on hand concurred with Wolkoff, an executive vice president with Fleet Bank. Joining her on the panel were banker David K. Drumm of Anglo-Irish Bank and Douglas MacLean, a senior vice president with Banknorth. Market research expert Stephen M. Coyle delivered the keynote address at the event, which was sponsored by the Massachusetts chapter of the National Association of Office Properties and Boston law firm Riemer & Braunstein.
Drumm also predicted activity will be sluggish until mid-2003. The president and CEO of Anglo-Irish Bank’s North American division anticipates a “muted recovery” to begin at that point, which ultimately should trickle down to real estate. MacLean said solid underwriting efforts will ease the pain of the slide, adding he sees the current environment as “more of a sideturn than a downturn.”
All of the speakers marveled at how firm underwriting guidelines have remained, with little evidence that the boom period of 1998 to 2000 relaxed the resolve to nix marginal projects or acquisitions that do not make sense. Meaningful equity required in transactions, stringent recourse rules and long institutional memories that recall the brutal 1990 collapse of the real estate market appear to have kept lending in check, with MacLean reporting that most real estate professionals seeking loans have acted responsibly.
“No one has been bringing us [deals] that we can dismiss out of hand,” said MacLean, adding, “It has been a real partnership with [borrowers].” Although foreclosure rates have begun to creep up in some markets, MacLean said they have actually declined over the past 12 months for Banknorth. Wolkoff said Fleet’s $20 billion commercial real estate portfolio has also remained solid. The bank has seen the number of loan requests dwindle, she said, especially for construction lending.
Coyle said construction has ramped down in response to the economic difficulties, with national construction starts off by 32 percent this year, and by 70 percent in Greater Boston. “Construction reacts pretty quickly to slowdowns in demand,” said Coyle, who recently joined Citigroup after serving as director of market research for Boston-based Property & Portfolio Research.
In his remarks, Coyle said the continuing malaise of the national and local economies has had a definite impact on property conditions, with the office market hit especially hard. “We still see weakness in property markets,” he said, although it does appear the capital markets remain bullish on the asset side of the business. While empty, poorly located buildings are not seeing much interest, domestic and overseas capital has fomented an intriguing rush in recent months to buy well-stabilized real estate buildings, with Boston a top focus among investors.
Coyle attributed the interest despite erosion of market fundamentals to a lack of other investment options. For all of its difficulties recently, real estate has outperformed stock funds over the past one-, three- and five-year periods and Coyle said “capital flow to real estate still remains strong today.” There are some fears that the excess capital could lead to a “pricing bubble” for properties, but Coyle said rates have still not hit the peak pricing seen in the previous up cycle, making it less likely there is such a bubble on the immediate horizon.
Less Bad News
All bankers speaking last week expressed interest in funding deals if they do make fiscal sense, with Wolkoff and Drumm explaining they will entertain offers on all product types. MacLean said Banknorth has placed a moratorium on hospitality deals, but otherwise is in the game looking to finance reasonable proposals.
The bankers also offered other aspects of their institutional strategy. Drumm, whose Ireland-based firm arrived in the Hub in 1998, said the bank has sought to focus on its core business of commercial real estate lending, improving its connections locally by creating relationships with key players in the market and weighing transactions as they are brought to the bank rather than chasing projects on their own.
“I think you have to look at it these days on a deal-by-deal basis,” he said. Underwriting has changed rapidly, he said, reflecting the demise of the market, especially for office space. “It is nigh impossible to determine where [office] rents may end up,” said Drumm, adding that other elements such as generous tenant improvement allowances and even free rent are beginning to creep into the equation, further clouding the direction in which rental rates are headed.
As with Banknorth and Fleet, Drumm said Anglo-Irish does typically require recourse rules of some kind, although the bank will relax those terms if a deal and its sponsorship are especially solid. Anglo-Irish also tries to build flexibility into such areas as pre-payment, he said, adding that the bank’s current portfolio has loans ranging from $1 million to $100 million. Anglo-Irish typically holds onto its own loans, Drumm said, and offers a range of products from short-term construction to 15-year permanent notes.
Maine-based Banknorth’s growth strategy has been through acquisition of existing institutions, having gobbled up 20 banks since 1994, increasing the bank’s size from $2 billion to $25 billion in just a decade. The firm is already a leading commercial real estate lender in Maine, New Hampshire and Vermont, and MacLean said Banknorth hopes to aggressively grow that business in Massachusetts as well, where it now has $9 billion in assets.
“We are comfortable with all loan types,” said MacLean, save for the hospitality sector. Banknorth is also a recourse lender, but MacLean said it would do limited-recourse deals in certain cases.
Fleet’s loan pool ranges from $5 million to $200 million, with an average size of $12 million. The bank concentrates on its core market of Maine to Pennsylvania, Wolkoff said, with the Massachusetts portion amounting to about $2.5 billion annually. The deals tend to be short-term, she said, estimating the annual runoff to be about $800 million to $1 billion. With a mezzanine debt option, Fleet can provide financing of up to 85 percent loan-to-value, said Wolkoff, adding that the firm is also willing to consider funding a repositioning of an asset in certain circumstances.
All three lenders said the most prominent loan type being sought to date has been multifamily, with both apartment rental and condominium proposals leading the lending charge. Overall, Wolkoff said. “I feel very good about the state of our portfolio and the state of our customers.”
As for the near term, Coyle agreed with the bankers that Boston is unlikely to see improvement in the coming months, estimating that mid-year 2003 is the best scenario for the market stabilizing. Boston’s double whammy from the struggles of both technology and mutual funds could make for a longer recovery, Coyle said. The Bay State lost another 3,700 jobs in July, bringing the total local demise of jobs from mid-year 2001 to 45,000 positions.
Ironically, Coyle said wages in the Bay State have increased on average by 3.7 percent in the past year, adding that could prove a potential problem if it makes the state less competitive with other regions. There is already a migration of workers leaving the state, he said.
On the plus side, Coyle said it does appear the negative trend in the office market is beginning to ebb. Nationally and locally, vacancy rate decline has slowed, as has negative absorption. After the country saw 25 million square feet of negative absorption in the first quarter 2002, Coyle said there was just 5 million square feet negative absorption in the second quarter. “Things are getting less bad,” he said. “That’s the good news.”
