Call it a silver lining. Call it a sign that the worst is yet to come. Either way, says Tom Mitchell, a real estate lawyer with Pepe & Hazard, 2008 is not 1990. Not yet anyway.
"In the ’90s, I didn’t see a new loan for a year and a half," Mitchell said. He hasn’t seen that type of deep freeze yet. "There’s money out there," Mitchell insisted. "Deals can be made."
Deals can be made. At the end of a year in which the Dow suffered a prolonged freefall, Lehman Brothers failed, Bear Stearns, Wachovia and Merrill Lynch collapsed, the Federal Reserve cut interest rates to near zero, and the Treasury launched an unprecedented bank bailout program, commercial real estate deals can be made. It’s who’s making those deals, and how many they’re willing to make, and under what terms, that makes this a particularly precarious time for borrowers.
"Spreads are widening," said Jay Doherty, president of Boston developers Cabot, Cabot & Forbes. Doherty is currently rounding up financing that will allow construction at his massive Westwood Station project to go vertical this coming spring. It won’t be cheap. Doherty’s seeing spreads on loans reaching between 300 and 400 basis points. Mitchell, who works out of Hartford, has seen spreads double – and even triple.
Lending Coming To A Standstill?
Loans have become more expensive, in part, because banks have constricted the volume of money they’re lending out. "Banks are decreasing their exposure, so they don’t have as much money to lend," said developer John B. Hynes III.
"Activity has slowed, no question about that," Mitchell added. "Most banks are still engaging in some activity. I haven’t seen the spigot shut off yet."
But banks are tightening up their underwriting, looking more closely at borrowers’ income streams, and demanding much more equity in deals. And that due diligence has dramatically slowed the pace of lending. "I’ve been closing commercial real estate loans for 28 years, and this is the quietest fourth quarter I can ever remember," said Scott Cooper, the chair of Holland & Knight’s real estate finance group.
The makeup of the lending market has also dramatically altered the availability, and price, of capital. Wall Street investment banks have all but stopped making loans, while large national and international banks, unsure of their exposure to sour mortgages, have slowed the pace and volume of their lending activity. Community banks are flourishing in this environment. But community banks also aren’t able to make the sizable construction loans that developers like Hynes and Doherty need. So they’re forced to play Jenga, stacking up bits of capital and hoping the tower doesn’t come crashing down.
"You need the involvement of more than one bank," Doherty said. "A lot of people have lending ceilings of $50 [million] to $75 million. So if you’re looking for a construction loan of $500 million, you need two or three or four major lenders, and some smaller lenders contributing $20 [million] to $30 million each. That’s the way deals get done."
Hynes has become, in many ways, the face of this rapidly changing lending market. Work on his project at One Franklin, a 1.1 million square-foot office, hotel and residential complex atop the former Filene’s, stalled months ago when he and his partners were unable to plug a $50-million hole in their financing. He has been forced to scale back the size and scope of the development. And he needs to reassemble $300 million in financing for the new $525 million design.
"A year ago, when we needed $525 million, it was from three or four banks," Hynes said. "Six months later, of those same three or four banks, two have disappeared, and the other two have said, ‘We’ll give you half.’ We’ve increased our equity, decreased the loan amount and we need to put six or seven banks in play." By contrast, Hynes said, "We did One Lincoln Street in 2000, 2001, and we used one bank. They gave us $350 million."
On Dec. 12, Hynes’s lawyer wrote a letter to the Boston Redevelopment Authority detailing the changes to One Franklin. The project has been reduced by seven stories and 150,000 square feet, and has lost its residential component entirely. It has also picked up 100,000 square feet of office space. That’s because, Hynes said, big lenders have lost the appetite to finance new condominium construction, at any price, in any market. "Residential is a lightning rod, nationally," Hynes said. "Boston might be a stronger market but, nationwide, lenders aren’t interested in it. These loans aren’t originating in Boston, and national and international lenders are saying, ‘No residential.’"
On the commercial side, lenders are seeking "greater certainty and security every day," Doherty said, with "only the very best projects" getting financing. On the office side, that means having tenant commitments for 70-75 percent of space; retail projects have to show 70-80 percent of space is "deeply committed." Tenant lists are also getting much closer scrutiny.
Developers have had a decision to make: whether it’s best to claw through the market and assemble piecemeal financing packages, or sit and wait the market out. Joe Fallon has chosen the latter path. Asked recently about financing for his second Fan Pier tower, Fallon replied, "We haven’t explored it further. We’re letting things settle this year, and we’ll go back at it next year. Over the next two quarters, we’ll evaluate where things are." Fallon reasoned, "We have significant debt needs in the capital markets, and the equity that we’d been able to place before just isn’t there."
"Money’s really tight, and those with cash are in the driver’s seat," said Jeffrey Libert, chairman of Forest Realty Funding. "They’re in the position to really sock it to the borrower." The only way Libert made money this year, he said, was by shorting the S&P. "Any investment we made in the spring or summer looks horrible – we just did a couple, and we’re not losing money on them, but you could do the same thing now for 50 cents on the dollar."
In Libert’s view, yields from commercial mortgage backed securities have become so attractive that it’s not in some lenders’ interests to make new loans.
"If you’re a lender, why would you accept anything less than mid-teens? Why make an origination loan?" Lenders can’t compete with cheap, federally-backed capital, he said, so funds like his have either gotten into bed with the feds, or are driving "really onerous" hard money loans. "You’ve got to be in dire straights."
Costs will come down and volume will rebound, Doherty insisted.
"Now banks are using cheap capital to rebuild their balance sheets. They’re trying to rebuild from their losses and from their bad loans. It’s ironic that monetary policy has been set to encourage them to lend, and it’s brought about an opposite set of behavior. This will change. Confidence will come back. I compare it to 1989-1990. The Fed lowered the cost of capital, and banks retrenched their lending and started to weed out their bad loans. They put out money expensively and securely."
