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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 lending, insist they now suffer from a liquidity crunch of immense proportions.

And although they may exaggerating, the impact of a leaner lending environment is reverberating through the nation's real estate markets, including booming Southern California.

Many building purchases have fallen through. Development plans have been halted or scaled back. And trophy buildings that were once the subject of intense bidding are now lucky to get a second look from 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, who sold several of his properties to REITs for hefty profits in the last two years.

The credit squeeze is a warning, analysts say, that people in the real estate business should not 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.

Real estate money started becoming more scarce at the beginning of the year, when the specter of overbuilding and declining profits pushed down shares of most real estate investment trusts precipitously, blocking their access to Wall Street capital. Since January, REIT shares, as measured by Bloomberg's REIT index, have plunged 21.5%. That blow was followed by an uppercut in recent months, when a flood 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 who pool loans and issue securities against them, to promise huge spreads against yardstick 10-year Treasury notes. The price undercutting put many of these firms into the red, and forced some out of the business entirely, leaving investors and developers with far fewer choices for funding.

Total real estate lending by commercial banks fell to $9.2 billion from May through August, from $38.7 billion in the previous four months, according to PaineWebber Inc.

Those that are still loaning money demand that developers shoulder more liability. Instead of financing 80 to 95% of a building's cost, lenders now require borrowers to put in about 30% of their own money.

And loan rates, which had been priced just over 10-year Treasuries, are now priced a point to a point and a half higher--sometimes at 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.

This tightening of capital also has put the brakes on development. If it's not under construction now, analysts say, don't hold your breath.

"We are getting more conservative in our stance," says John Davenport, senior vice president of Menlo Park, Calif.-based Spieker Properties. The company has already started a few speculative office projects in Southern California, but it has scaled back plans for other development.

"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 gross exaggeration. Only the conduits are getting out of the business, they say. Portfolio lenders, or banks that hold on to their loans rather than securitize them, are still using the same underwriting guidelines. And their rates are still relatively low, from a historical perspective.

"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 just a small initial margin of return, the collapse of the commercial mortgage-backed securities market has meant the collapse of deals.

A Wall Street bank walked out in the eleventh hour on Santa Monica-based Kennedy-Wilson Inc.'s purchase of a Los Angeles office building, according to Nick Kanieff, president of the firm's commercial property division. The lender ultimately returned, offering funding if the company would put in more equity--$7 million instead of $1 million--and pay a higher interest rate. That put the high-rise out of reach, Kanieff says.

"It destroyed my return, so the deal was no longer attractive and I bowed out," Kanieff said.

Nationwide, purchases have been falling apart, brokers say, as lenders refuse loans or renegotiate them. And sellers, hoping to cash in at what they thought was the peak of the market, have been left holding the bag--and in some cases the buyers' deposits or so-called earnest money.

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