Next year may turn out to be one of the toughest years in recent times for developers of new office, retail, hotel and other commercial projects. A variety of negative forces, including the economic slowdown, overbuilding and unavailable funding, are making it increasingly difficult for all but the most sure-thing projects to advance to financing and construction, according to developers, real estate investment trusts and industry analysts.

Forest City Enterprises
The deal for an office building in Albuquerque was set up by Forest City before the meltdown.

 “There’s a lot of uncertainty out there,” says David Begelfer, CEO of the Massachusetts chapter of the National Association of Industrial and Office Properties, a developer group. “Tenants don’t know whether rents will be rising or falling, developers are unsure about whether to begin projects, and financial institutions are uncertain about whether to provide funding.”

Construction financing for office, retail and other commercial projects “is very difficult to get, not impossible, but the project has to be of very high quality with serious pre-leasing,” Begelfer says, adding that the scarcity of money to be lent also means projects need to be of relatively modest size.

Even institutions such as universities, colleges and hospitals are putting construction on hold because bond financing is “pretty much out of the question,” Begelfer says. Whatever bonds can be sold require unusually high interest rates, he adds.

Phoenix office construction appears to be strong today, but a slowdown is looming, says Phillip Breidenbach, senior vice president of office properties at the Phoenix office of real estate service giant Collier International.  “About 5.25 million sq ft of office space is under construction right now, most of it for 2009 delivery,” he says. “Those projects will continue, but as far as how many new projects I think will get under way in 2009? I would say none.” Uncertainty and the unavailability of credit are the reasons, he says.

Projects most likely to move forward are those that had lined up tenants, financing and other prerequisites before the national banking system and Wall Street started unraveling this fall. For example, Forest City Enterprises, the Cleveland-based developer, last spring closed on a $31.6-million loan for a 210,000-sq-ft office building it now is constructing for a unit of Fidelity Investments at Forest City’s Mesa del Sol mixed-use development in Albuquerque.

In September, despite what it called “a virtually frozen credit market,” Forest City closed on $250 million of construction financing for 628,000 sq ft of fully leased office and retail space at the Waterfront Station mixed-use redevelopment project that it is developing with Bresler & Reiner Inc. and Vornado/Charles E. Smith in Washington, D.C. “It’s a very tough market out there,” says Forest City Vice President Jeff Linton. “Our loan originators are talking to 10 bankers for every one or two they used to. Still, an awful lot of our success [in securing financing] is tied to relationships.” While construction financing was once dominated by regional and local banks, developers increasingly are turning to sovereign wealth funds, foreign banks and syndication arrangements, says Forest City.

The institutions participating in Waterfront Station’s construction financing include Bank of New York Mellon, which will serve as administrative agent for the lenders, as well as Bank of Ireland, Wachovia, PB Capital and the New York branch of Landesbank Baden-Wurttemberg.

An atypical financing source also is helping to advance the $1-billion Concord Empire Resorts Hotel and Casino project in New York’s Catskill Mountains. Empire Resorts Inc. and Concord Associates LP said in early October that they have received a commitment from Union Labor Life Insurance Co. to provide $250 million of the $1-billion construction loan that the developers are assembling for the project. It will consist of a 750-room hotel, a convention center and a casino and related commercial space. Union Labor Life is making the investment through its investment vehicle, “J for Jobs,” which provides financing to projects that create union jobs. David Hanlon, CEO of Empire Resorts, says construction at the Sullivan County project site “is progressing as planned.”

Hotel construction in the U.S. is still booming but will slow significantly by 2010 as that industry copes with an expected decline in demand for rooms this year and next, according to Mark Woodworth, president of PKF Hospitality Research, Atlanta. U.S. hotel owners have added an average of 72,000 hotel rooms a year over the past 20 years, and after a mid-decade slump in building activity, plan to add 116,000 rooms this year and a record 158,000 in 2009, Woodworth says. But demand is sagging and Woodworth anticipates only 69,000 rooms will be added in 2010. “That’s not awful” from a historical standpoint,  but it certainly signals a slowdown, he says.
The situation is more dismal in the retail sector, which has been experiencing rising vacancy rates. “We expect about 148 million sq ft of retail space to be added in 2008, but that will drop to about 90 million sq ft next year and fall another 40% in 2010,” says Suzanne Mulvee, research  strategist at Property & Portfolio Research of Boston. The retail projects to be completed in 2009 are “generally locked and loaded,” she says, adding that very few projects that are not already pre-leased and financed are likely to come online next year. In addition to the credit crunch, retail will be hampered by declining consumer spending, the trend among troubled retailers to close stores and the move among even stronger retailers to slow the pace of new-store additions, Mulvee says.

There will be local bright spots, but they may be scarce. In the still-vibrant suburbs south of Austin, for example, David Berndt Interests, Irving, Texas, is starting construction this fall on Kyle Crossing, a one-million-sq-ft retail and restaurant complex to be developed in phases over the next year or so.

Some retailers are looking ahead. In mid-October, Target opened two new prototype stores: a SuperTarget store in Otsego, Minn., with 186,000 sq ft, or 12,000 sq ft more than the company’s existing supercenters, and a 132,400-sq-ft general-merchandise prototype in Waconia, Minn., which is 6,000 sq ft larger than the current footprint. Both prototypes are certified under the U.S. Green Building Council’s Leadership in Energy and Environmental Design. Target plans to develop more than 100 of the new stores in 2009.