How low can it go? That is the question being asked this fall by developers as the economic recession rips through commercial markets with a vengeance, knocking out many projects and lenders and casting uncertainty on the future.
With construction investment down nearly 20% this fall and a host of banks failing due to defaulted construction loans, commercial construction has slowed to a crawl. Developers can do little more than wait for the situation “to finally hit bottom,” says Cami Hardee, marketing director at Woodbine Development Corp. The Dallas-based developer is weathering the downturn, with two major hotel projects currently under way. Despite the climate, Woodbine was able to finance the projects through “good, longstanding relationships” with lenders, Hardee says.
While there are examples of similar projects chugging along across the country, “money is on the sidelines,” says developer Douglas Howe, president of Seattle-based Touchstone Corp. and chairman of the National Association of Industrial and Office Properties, Herndon, Va.
According to the Federal Deposit Insurance Corp., about one-sixth of all construction loans were in default this summer. Developers are at the center of the crisis as a host of commercial projects stall, including mixed-use, hospitality, retail and office buildings. At the end of June, $291 billion of construction loans were outstanding, says FDIC.
Lenders face “a severe deficit going forward; it is a liquidity crisis, and loans need to be cleared out,” Howe says, noting that “zombie banks” exacerbated the crash by “ignoring the problem and lending, extending and pretending.” The ultimate question this fall for developers is “how to unfreeze credit when most will have only 40% to 50% equity going forward,” Howe says. “I haven’t got a clue how we will get through that.”
The real estate development mantra that “location, location, location” is the key to success has changed to “finance, finance, finance,” says John Scovell, Woodbine chief executive officer. “It is going to be difficult to find equity partners now, and if we walked into a bank now for financing, the chances are not very good.” Scovell says despite the dire markets, there were strong enough indications of demand for the firm to plunge forward on two approximately $30-million Hyatt Place hotel projects this year—an 81,000-sq-ft, 127-room hotel in Phoenix that was finished in spring, and a 135,000-sq-ft, 214-room hotel in Sugarland, Texas, that is on target for completion in 2011. “We are taking advantage of the low cost for construction and land,” says Scovell. The recession “does not scare us. You have to take a long-term view. In this market, you cannot just flip [a property].”
According to Howe, two bright spots are steady demand for government projects and the bull markets that likely await on the other side of the recession. “When we get through this, the opportunities are going to be better than ever,” Howe says. Speculators already are eagerly eyeing distressed properties, with the down market presenting bargain-basement prices for those able to invest, says Daniel Queenan, president and CEO at Chicago-based developer Opus North. “There will be growth opportunities through acquisitions and build-to-suit projects on land you already own,” Queenan says.
Opus North currently has several projects in the works, including two at Marquette University in Milwaukee: a $75-million, 200,000-sq-ft law-school building and a $25-million, 120,000-sq-ft student-services building. The firm also is in the first phase of a $40-million, 150,000-sq-ft mall called Shoppes at Fox River in Waukesha, Wis., and a $38-million build-to-suit project for Capital Group in Indianapolis.
“We are busy still but are not starting anything on a speculation basis now,” says Queenan. “We are working with...