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Developers, Investors Say There's a Credit Squeeze

Real estate: Lenders call that an exaggeration. But as the rules have tightened after years of easy money, deals are falling apart.


Call it overstatement--or even whining--but real estate developers and investors, spoiled by low interest rates and years of eager lenders, insist they're facing a serious liquidity crunch.

Although some in the industry may be exaggerating the troubles they face, it is clear that the lending environment in Southern California and elsewhere in the nation is less hospitable than it was even a few months ago.

Many building purchases have fallen through. Development plans have been shelved or scaled back. And trophy buildings on the market that were once the object of intense bidding are now lucky to attract a second look from prospective buyers.

"Whereas before we might have eight to 10 bidders for a property, now there are only two to four," says Stuart Rubin of Los Angeles-based Rubin Pachulski Dew Properties, an owner of hotels, office buildings and shopping centers. Rubin said he sold several of his firm's properties to real estate investment trusts for hefty profits in the last two years.

The credit squeeze, whatever its dimensions, is a warning, analysts say, that people in the real estate business can't get carried away like they did in the last boom.

"This is sort of a wake-up call," says David Dale-Johnson, director of the real estate program at the Marshall School of Business at USC. "The markets are more in tune now, so I don't think we're going to get as overbuilt" as in the last cycle, in the 1980s.

Real estate money started becoming more scarce at the beginning of this year, when the specter of overbuilding and declining profits pushed shares of most REITs down precipitously, sharply limiting their access to Wall Street capital. Since January, Bloomberg's index of REIT shares has plunged 21.5%. That blow was followed by an uppercut in recent months, when a large number of mortgage-backed securities hit the market just as U.S. investors were getting jittery and demand from mortgage REITs was cooling. The oversupply forced so-called conduit lenders, or lenders that bundle loans and issue securities backed by these, to promise huge spreads against yardstick 10-year Treasury notes. These huge spreads made it impossible for some lenders to turn a profit and drove many of them out of the business, leaving investors and developers with far fewer choices for funding.

Total real estate lending by commercial banks, of which commercial mortgage loans are just a part, fell to $9.2 billion from May through August, from $38.7 billion in the previous four months, according to PaineWebber Inc.

Those who are still lending money demand that developers shoulder more risk. Instead of financing 80% to 95% of a building's cost, which was typical recently, conduit lenders now require developers to contribute about 30% of a project's cost themselves.

And commercial mortgage loan rates are now priced a percentage point to a point and a half higher--sometimes totaling 8% or more, says Richmond, Va.-based mortgage banker John B. Levy.

"They want to make sure this time they don't get hurt, and they want to make up for some of the losses they have been taking," Levy says of lenders' new caution.

This tightening has, in turn, put the brakes on development. If it's not under construction now, analysts say, it may not be any time soon.

"We are getting more conservative in our stance," says John Davenport, senior vice president of Spieker Properties, a Menlo Park, Calif.-based REIT. The company has a few speculative office projects underway in the Southland, but it has scaled back plans for other development here and elsewhere.

"The easy money has gone away. If developers are going to build, they are going to have to [sign tenants] first," Davenport says.

Real estate lenders say talk of capital drying up is a gross exaggeration. Only the conduit lenders are getting out of the business, they say. Banks that hold on to their loans rather than securitize them have not instituted any draconian new lending guidelines, they say. And from a historical perspective, their rates are still relatively low.

"Candidly, rates are as low as they have been in--how many years?" says Molly McCabe, principal in Mill Valley, Calif.-based Bridger Commercial Funding. "Generally speaking, to get a loan under 9% is pretty good."

But for investors who have little to put down or were aiming for a narrow initial profit margin, the collapse of the commercial mortgage-backed securities market has meant the collapse of deals.

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