Feature Stories - Aug 6th, 2008

The Money Crunch

He Says... She Says

by Dennis Hetherington

Commercial Real Estate fighting can be compared to the ongoing “battle of the sexes” with developers and banks acting out the part of the couple.  The developer says this, the bank says that and the battle continues.

The Developers

Developers say they want to develop, they want to build, but they can’t because banks are telling them they don’t have the money or won’t lend it if they do. Bankers, on the other hand, deny this, insisting they have money to lend and do. As in so many disputes between couples, the truth lies somewhere in between. Thus you have the current state of commercial real estate financing.

“It’s completely true,” says Loren Miller, president and owner of Winmill Development, adding that the banks aren’t releasing any funds. “The small banks have money but the terms are so tight,” he insists. “And the big banks have tightened up completely.”

According to Todd Nigro, president of Nigro Development, financing land acquisition is the biggest challenge facing developers today, although he notes construction financing is also tough, depending on the market. “Generally, land acquisition is the hardest [to get financing for] because there are just two ways to get out of land. One is to sell it, which, if you buy land right now with the expectation you are going to turn it quickly is probably unrealistic,” he explains. “The other way to get out of land is to build on it.”

That can be iffy, says Nigro, because getting financing to build may depend on where the land is located and what it’s going to be used for. “The chances of building on it may be good or bad.” He explains the easiest financing to obtain, which he admits isn’t really easy to get at the moment, is financing when your project is stabilized. “When a project is stabilized you have more options, so you can go to outside sources such as Wall Street or the international market.”

Nigro, who also sits on the board of directors for Bank of George, says that Nigro Development gets the majority of its money for construction from local banks. Typically, local projects get financed by local institutions because, for one reason at least, local lenders understand the market.

The preference to work with local lenders is echoed by Miller of Winmill Development who says he has dealt with an out of town bank only once.  “They didn’t understand the Las Vegas market and based their assumptions on their experience in their local market.”  

Nigro says local lenders are more suited to lending in a local environment and – in some cases – not lending in a local environment. If they perceive risk in a certain type of product or in a certain part of town, they may not lend to it. He also points out that a fair amount of money came to Las Vegas from out of state over the last five years. “I would guess some of that has gone away.”

The Bankers

Just as in the game of love, there is the other side, the banker’s side.   At Nevada State Bank (NSB), Dallas Haun, president and CEO, says the money is there, but market conditions have changed the way banks make loans. “A basic philosophical change in our company, and I’m sure it’s the same thing for other lenders, is that we’re not looking to establish just a lending relationship with a developer,” says Haun. “Instead, we want to be their total banking partner for all their banking needs, including deposit accounts, treasury services, and wealth management. We are looking to establish a holistic relationship with each and every one of our borrowers.”

The bank is also taking a closer look at the developer’s global financial position, not just the economics for the project being financed. “NSB looks at the overall liquidity of the company, its other liabilities and the operating cash flow from the overall real estate portfolio, and its ability to weather the current real estate downturn,” explains Haun, who gives an example. “If the developer has a large land loan from another lender coming due in six months, will it be able to make that payment, or will that negatively impact the company’s cash flow and eventually affect our project? We’re looking beyond the deal immediately in front of us.”

Speaking generally of all banks, Haun says developers will find higher interest rates, lower loan to values, higher pre-leasing requirements, lower spec limits and requirements for stronger sponsorship (guarantor support).

“We have not cut back on commercial real estate loans,” emphasizes Diane Fearon, president and CEO of the Bank of George. “The Bank of George has the capacity to make good loans in commercial real estate and for other business purposes.” A good loan, says Fearon, is somewhat defined by considering market definitions, along with loan portfolio concentration factors.

Pointing out that Bank of George is newer, Fearon says they are very aware of what percentage of their overall business can be dedicated to land loans or construction lending. “We can make loans for land purchase, construction and the purchase of existing commercial real estate because our loan portfolio is evolving and being built. I haven’t reached capacity in any particular concentration or product type.” Part of the story, says Fearon, is that despite headlines to the contrary, commercial real estate transactions are still being done by banks today, but admits it is more challenging to have a commercial real estate transaction make sense as far as the viability of producing cash flow, servicing debt, and making a profit for the developer.

Bill Oakley, southern Nevada regional president for First National Bank of Nevada, readily admits credit markets are tight now. “I’m not aware of any bank in our market that hasn’t cut back on real estate lending today,” he says. “Lenders who are in the commercial market are sifting through deals and cherry picking the absolutely most credit-worthy transactions to finance.” He points out that difficult transactions like speculative office buildings, or even retail projects that don’t have certain levels of leasing, won’t be financed in this market like they would have been just a couple years ago. “Before, the markets were very liquid and lenders were fighting for deals.”

Service 1st Bank, according to Chief Credit Officer Richard Deglman, is still in the lending business for commercial real estate. “We’re still a lender with a green light,” explains Deglman, who points to cherry picking by banks, including his own, to get the best deals. “If it makes sense, we can do the loan.” Deglman says Las Vegas is now a market where bankers are more in demand and in limited supply. “We have the upper hand in negotiating with the client because there are fewer banks making loans.” He points out that while this puts the consumer at a disadvantage, the cycle will turn to where the consumer will again have the upper hand. In the meantime, banks are being choosier on the loans they make.

Many developers don’t realize that banks are struggling with capitalization and their financial health is marred by loans that turned sour, contends Deglman. “The bottom line is we don’t have as many funds to lend as we once did, so we are picking the deals that contribute the most.”

Bill Uffelman, president and CEO of the Nevada Bankers Association, also echoes the comments of his member banks. “Money for commercial real estate development is tight, but given the state of current market conditions, it depends on a number of factors.” Generally speaking, it is still possible for developers to get money, he says, but the banks will see how each project pencils out. It depends, in part, on the depth and strength of the developer seeking the financing. Individual banks are making individual decisions, explains Uffelman, noting that some are lending, some aren’t, and that each project has to be evaluated on its own merits. “I can tell you this,” says Uffelman. “There is no more ‘pie in the sky’ financing going on.”

The  Crunch

There you have it. He says, she says. Claims and counter claims, with no apparent winner or loser.  Generally speaking, Nevada’s commercial real estate market is in an environment new to some, forgotten by others who had experienced it before. Yes, money is available, but not nearly as readily and easily obtained as it was during the late boom. Yes, banks – at least some banks – are still making loans, but to qualify is far more challenging and the terms are much more restrictive. If a good developer has a good project, he can get financing. If the developer is deficient or mediocre, or if the project is flawed or second-rate, it probably won’t be financed.

Consider, for a moment, if that had been the case in residential financing a few years ago when some of the biggest lenders threw caution to the wind and abandoned conventional lending practices. They not only shot themselves in the foot – the head for some – but shot a lot of others in the process. Had they stuck to conventional wisdom about qualifying homebuyers for loans, much of the current mortgage crisis and credit crunch would have been avoided. And commercial credit would be more available today.

Future Development

Somewhat left unsaid in the argument between developers and bankers is whether there is a current need for continued development. Financing issues aside, do current market conditions merit development on the scale that Nevada has witnessed over the past few years.

The office market in the Las Vegas Valley has averaged about a 9.7 percent vacancy rate over the past 10 years, says Brian Gordon, principal of Applied Analysis. “Today, we’re at about 16.7 percent, so we’re well above the historical rate,” he adds, noting that some submarkets are reporting vacancies in excess of 20 percent. “Certainly, some areas are reporting an imbalance today relative to where they should be that will take time to work through that excess level of inventory.” Using the 2007 absorption rate, Gordon says there is probably a year and a half of excess capacity in the office market today, not including the capacity that is currently under construction and expected to enter the market this year.

Industrial vacancies, which reached record lows in the three to four percent range in 2005 and 2006, are today running almost double at 7.7 percent, reports Gordon. He says it causes some concern when any vacancy rate doubles, but it’s still in line with the historical average over the last decade of 7.6 percent. “When vacancies shoot up fairly rapidly there is concern, but it’s all relative to where the market has been,” he says, ending on a positive note by pointing out that deals are still happening and in the industrial segment, there was 700,000 square feet of positive net absorption the last quarter.”

At commercial real estate brokerage firm Lee and Associates, Lisa Gilstrap CCIM,  principal and vice president, and Associate Brian Seibold, say that as a whole, there is plenty of office product in that market which is soft now. They point to a shortage in the construction of certain commercial sub-types being built, such as warehousing, light and heavy distribution and flex.

They mention that everything is affected, but commercial hasn’t taken the direct hit the residential market has.  Despite a lot of downsizing, they believe the market is still strong and viable, but many people are scaling back their operations. In spite of the down market, both say they are having a good year and point to good growth in food and bottling plants, exposition companies, distribution, slot machine manufacturing, linen services and uniform supply.

Is now a good time to develop new commercial projects? It depends on who you are listening to, but many developers are inclined to “wait and see.” “Everybody is sitting around waiting for improvement in the market,” says Wes Jenson, senior vice president for Stoltz Real Estate Services. “There is not much interest in available space … there is more available space than interest.”

“It is interesting,” says Nigro, “because three or four years ago when the market was strong, I would get unsolicited phone calls every week and now those calls don’t come in any more.  Using a baseball analogy, Nigro said that three or four months ago, we thought we should have it all worked out by the end of 2008. “Now it looks like the first inning could last longer than the entire ball game.”

“I don’t think this market will change for at least 18 months,” says Miller of Winmill Development. “Basically I’m just sitting back … and won’t start anything new until I see the market change.  I can wait this thing out.”

Bankers, brokers and developers alike can heed the words of Gilstrap and Seibold. “Those of us in business for a long time have gone through up and down cycles, good times and bad times, and have learned how to weather these cycles and changes in the market. It’s not necessarily doom and gloom for us,” they insist. “As long as the market is not stagnant, we can make money.”