COVER STORY, FEBRUARY 2009

SOUTHEAST FINANCIAL UPDATE
Small banks, apartment deals stay active during recession.
Jon Ross

The story of the current lending market is one of geography. To some extent, a city’s location has always dictated what commercial property type will be a perennial hot item, but in this current economic climate, finding good news takes some looking at the map. A city hit hard by the recession may lie a few hours away from a relative real estate oasis. In Louisiana, hurricane recovery is still fueling the real estate market, and in Raleigh, North Carolina, stable employment has led to a level multifamily vacancy rate.

“Many owners and regional managers have told me that Raleigh is still the best performing market in their portfolio,” says Sperry Van Ness| AIM Real Estate Advisors’ Scott Bush from his Raleigh office. Busch focuses on the area’s multifamily market. “Buyers and sellers are still very optimistic in this market.”

Areas where the commercial real estate market is still relatively healthy have one thing in common: regional banks rule. Unlike larger institutions, these local banks haven’t been tied down by the ballooning number of problems the national banks are juggling. “Larger banks have been in the real estate market for a lot longer and have had much larger allocations on a year over year basis,” says Saul Hoppenstein, who works in the Boca Raton, Florida, office of Tavernier Capital Partners. “The smaller banks have always had a limited amount of capital to deploy on a year over year basis and thus do not have as many problematic loans in their portfolios currently.”

This means that local banks that cater to developers and investors in communities like Raleigh and Baton Rouge, Louisiana, are fairing better than their larger counterparts. “They seem to be doing pretty well,” says Hays Alexander, a partner at the Baton Rouge law firm Kean Miller, which specializes in mergers and acquisitions, developer representation, real estate finance and zoning issues. These banks, he continues, are conducting loans for amounts smaller than $10 million. “They’re not making huge loans, and they’re obviously being a little bit more conservative, which is understandable given the current credit market.”

Regional banks are helping fuel the market in smaller cities, but the real estate market in Louisiana has a large factor working to its advantage. Recovery from Hurricanes Katrina and Gustav has created a pro-development environment in the areas hit by the storms.  While most of the region is cutting back on development and deals are slowing down, Alexander sees a steady amount of loans coming through his office. Redevelopment has mixed a certain amount of recession repellant into the economy, but the nationwide economic downturn has slowly started creeping into the area. “There is a slowdown based on what’s affecting the rest of the country, and I think that has happened in ’08. I’m hoping it doesn’t happen in ’09,” Alexander says. “The indications from the local business leaders and banks that I’m getting is that there will be an effect, but I don’t know if we’ll get to the point that the rest of the country is in right now.”

Even in economies that welcome real estate deals, caution is still advised. Banks aren’t throwing money at every investor, no matter how strong the project seems. Alexander tells his clients to be absolutely certain that both parties in a transaction can get loans before moving forward. “I’ve had a couple of deals where we reached the closing and there wasn’t any money,” he says. “The other side can assure you that they’ve got the money, but at the end of the day, if the banks don’t loan it, then it’s not going to happen.”

Funding from the Troubled Assets Relief Program has not trickled down to the industry, making it nearly impossible to reinvigorate the real estate market. “Right now capital is very, very hard to come by, especially for new projects,” says Charlie Bello of KeyBank Capital Real Estate’s Atlanta office. “As far as I’ve been able to see, the TARP money that’s flowed out to banks has not made its way to borrowers. The financial institutions are really in a quandary as to where the economy’s headed and how things are going to work and play out during the next 12 months.”  Bello works on the permanent financing side of KeyBank’s operations, and he has seen his loan requests diminish in the past few months. “Most people are aware that it’s a very difficult market in which to obtain financing. If it’s a construction loan, unless it’s a particularly fantastic property with very strong sponsorship and all of the right ingredients, it’s very difficult to finance deals in this environment.”

One relative bright spot across the board is the multifamily sector. In Atlanta, Bello has handled a record number of financing deals for multifamily borrowers, and in Raleigh, Busch champions the city’s multifamily options. In a market of 96,000 units, there are 3,000 more in progress. He sees no distressed properties on the horizon, and, even after a slight increase in supply, market-wide vacancy is coming in at around 9 percent. There are, however, some indicators that multifamily will soon go the way of retail and office. “We’re seeing rents starting to decline a little bit,” Bello says. “There’s a direct relationship between employment and housing, and we’re starting to see that issue hit on the multifamily side with people either doubling up or people actually returning home to live with their parents.” This trend goes against conventional wisdom that when the economy suffers, demand for multifamily properties increases. The argument is that people who are suddenly out of work are forced to downsize, moving from a house to an apartment. “That is a very interesting conundrum,” Busch says. “You do see homeowners downsizing, but you also see apartment renters downsizing. The net effect seems to have been a wash.”

While there are sectors of the market that are still doing well, other property types are fairing poorly. David Zanaty works for AIG in Atlanta, where he says 3 million square feet of office space is slated for completion in the next year. Only a small percentage of the space is currently leased. In this case, a tight lending market could have helped prevent rampant overbuilding. The next wave of trouble, Zanaty says, will arise when these loans mature. “[The loans] were underwritten based on fantasy values, assuming rising rents that haven’t happened or higher loan to values,” he says. “When lenders come back and adjust those pieces … that’s going to cause some distress.” As it stands, total office vacancy in Atlanta during the third quarter of 2008 came in at 16.7 percent. Taking into account only Class A space, the number rises to 18.3. “If this new space doesn’t get leased,” Zanaty says, “that’s going to raise that number by another 2.5 or 3 percent.”

Real estate analysts can’t know when the lending market will free up, but in the meantime, there are some dire predictions for certain property types. Retail is pegged as the one property type that will be most affected by the lending freeze and the recession in general. “We had a very dismal holiday season in terms of sales,” Hoppenstein says. “That is going to ripple through the whole retail sector. That’s going to continue for a good part of the year until things start to stabilize.” And how do things start to stabilize?

“That’s a good question,” he says with a laugh. “If I knew the answer, I’d probably be in Washington.”

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