Commercial Real Estate Update
 The Met 2 building (center, under construction) is one of three tower projects that will add almost 2 million square feet to an already struggling downtown Miami market. [Photo: Aerial Photography Inc.] |
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What Florida’s Markets Have in Common » Little new construction begun recently » Projects under way often finish empty » Vacancies are up, rents are down » Troubled buildings can’t pay to build out space for tenants or pay broker commissions |
For that explanation, turn to property values — down 35% since 2007, says Moody’s Investors Service — and the banks.
The fortunes of commercial real estate and Florida banks are joined at the hip. Florida banks have $56 billion in loans for commercial real estate on their books — 34% of bank assets, according to FDIC reports.
They aren’t doing well. Severely distressed loans at Florida banks, as a percentage of assets, are 15 times what they were in 2006. At the end of the second quarter, Florida banks had $5.1 billion in commercial, apartment and construction and land development loans in default, up from $274 million in 2006, according to FDIC reports.
The worry is that commercial real estate owners won’t make good on the estimated $530 billion in loans maturing nationally in the next three years, triggering a new wave of bank failures and killing any budding recovery.
“A challenging situation right now. There’s no question about that,” says Bill Moss, senior managing director and Florida regional manager for CB Richard Ellis.
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How We Got Here ...
The Fallout
In the late 1980s, money from S&Ls fueled overbuilding. The culprit now, as in the residential market, is again easy credit, but this time it led to overvaluing, not overbuilding. The juice came in part from commercial mortgage-backed securities. Commercial property loans were bundled into securities sold as investments. Industry newsletter Commercial Mortgage Alert says such securities issues nearly tripled to $230.2 billion in 2007 from 2003.
Property prices inflated. At the peak in 2007, buyers were paying the highest multiples of a building’s rental income in at least 30 years. “Money was so accessible that people were buying buildings at ridiculous prices,” says Damien Madsen, a partner at Morrison Commercial Real Estate in Orlando. “When the music stops ... all of a sudden you’re owning something you overpaid for.”
Florida, with $2.1 billion in delinquent loans backing such securities, was third in the nation as of July, accounting for 8% of the national total, according to Horsham, Pa., credit-rating agency Realpoint. Agents for securities have filed foreclosure actions this year over properties ranging from a shopping center in Pembroke Pines to a warehouse in Miami.
The Dynamic
Commercial developers and many buyers finance their purchases with interest-only loans for fairly short periods, three to 10 years, to be paid off with a balloon payment at the end. The traditional exits are to sell or borrow again. The sales door is as good as shut. The few buyers out there want bargains.
The question then becomes who will refinance the billions in commercial real estate loans maturing nationally in the next three years. Values have fallen so far that refinancing is problematic at best. Consider an office building bought at the peak for $25 million and financed with a $20-million loan, for an 80% loan-to-value ratio. If it’s now worth only $20 million, the owner’s equity is gone. A lender isn’t likely to refinance the full $20 million debt since it would amount to loaning 100% of the property’s value. The owner, down $5 million already, isn’t going to be eager to put in more equity.
Notice that the issue isn’t occupancy. “A lot of these projects that could be challenged by this are very successful projects — 90% occupied,” says Moss of CB Richard Ellis.
 “Most of us are not going to pay off the balance of the loans when they mature. We’ll have to see when the deal comes to maturity whether it makes sense to extend or sit down and talk about a restructuring.” — Seth Werner |
Seth Werner, CEO of Hollywood-based Cypress Creek Capital, for example, says his portfolio, assembled for $400 million, has an average leverage of 70%. Now lenders want to lend only 50% and want guarantees. “Most of us are not going to pay off the balance of the loans when they mature,” Werner says. “We’ll have to see when the deal comes to maturity whether it makes sense to extend or sit down and talk about a restructuring.”
The Solution
The solution thus far has been for borrowers and lenders to agree on short extensions that have been described as “extend-and-pretend” and “kick the can down the road.” In the early 1990s, as commercial real estate values fell, lenders took over many failed projects and discounted rent or sold the failed projects to buyers who discounted rent — all of which only forced down the value of viable competing properties.
To avoid that cascade of falling values, says John Carey, managing partner at Whitehall Realty Partners in Jacksonville, “The feds have got to instruct the banks to be flexible.” Otherwise, “market values will plummet.”
In August, the Obama administration extended a bailout program to help the sector. Duane Stiller, president of commercial real estate owner and researcher Woolbright Development in Boca Raton, says lenders are only delaying the inevitable. Banks will have no choice but to clean up their books, breaking the impasse between buyers and sellers over values. Job growth — which usually lags in a recovery anyway — will at first just fill now-empty desks, not create enough demand to drive rental rates high enough to justify the levels of the 2007 peak and ease the refinance crisis. Industry insiders say it will be at least a year until the bottom is reached and a few years to sort out the wreckage. “It’s like after a hurricane — we’ve got a big mess to clean up,” Stiller says.
A Lesson in Timing
 Thomas Crocker |
Cashing out was nothing new for Crocker. He survived the last commercial real estate debacle, the 1980s overbuilding crash, and transformed himself from a big fish in a small pond, developing and selling a few landmarks, including headquarters for Office Depot and W.R. Grace and his pioneering Mizner Park retail, residential, office and entertainment project in Boca Raton, to be a big fish in a bigger pond. He assembled portfolios that spanned the Southeast United States, including one with 125 properties. He left that to build the one he sold in 2005, a 137-building portfolio whose lineage traced to legendary Florida developer Ira Koger.
Crocker reloaded, raising $200 million from pension funds, institutional investors and others — enough, once he leveraged it, to buy $500 million in property. But he mostly waited. Commercial real estate, he says, was priced for perfection. Values allowed for no economic hiccups, let alone a meltdown.
Now, as a veteran of two commercial real estate debacles, he sees opportunity — down the road. “The fundamentals in the office market are terrible,” says Crocker, 57. Owners and lenders haven’t faced up to swallowing their losses. Meanwhile, his backers “are very glad I have not brought anything for three years. We didn’t predict the global economic crisis. We did predict pricing had gotten out of control.”
Miami: Thinking Long Term
No market in Florida faces what Miami will next year: Three, new, top-tier office towers adding 1.9 million square feet to a market struggling with falling occupancy and lease rates.
 “The market has actually improved significantly from what it was six, nine months ago. That’s not to say we haven’t had to mark to market and be competitive to attract the quality of tenants we want. Existing landlords have been extremely aggressive.” — Tere Blanca |
Many of those tenants, too frightened by the economy to ink a long-term lease, instead sign short term with existing landlords who are eager to please. Meanwhile, the new builders must be cautious in leasing. Because building out space for a major tenant can cost millions of dollars, owners want multimillion-dollar deposits or letters of credit, something some prospects told Brickell Financial Centre developer Loretta Cockrum they currently lack the strength to provide.
Cockrum says her project never was meant to catch one market cycle. She calls it a flagship, “the Rockefeller Center of Miami,” eventually comprising two towers totaling 1.5 million square feet of office, retail and hotel. Her project has an advantage in being self-funded. “We will complete the building empty or half full or whatever it is.”
 1450 Brickell (under construction) [Photo: Aerial Photography Inc.] |
| 1450 Brickell Developer: Rilea Group Height: 35 stories Size: 586,673 square feet Completion: 1st quarter 2010 Financing: A $175.2-million loan from a 15-bank consortium led by Bancaja and Banco Sabadell Cost: $280 million Major tenants: None yet |
Brickell Financial Centre Developer: Foram Group Height: 40 stories Size: 600,000 square feet Completion: End of 2010 Financing: Self-funded Cost: $300 million Major tenants: None yet |
Met 2 Developer: MDM Development Group and MetLife Height: 47-story office tower and a 42-story hotel tower Size: 750,000 square feet of office space Completion: Spring 2010 Financing: A $250-million loan from Bank of America, HSBC Bank USA, RBC Bank, Bank of Scotland and the former Wachovia Cost: $500 million Major tenants: Greenberg Traurig, Deloitte, Business Centers International |
 [Photo: Jason P. Smith] |
Around the State
Miami: A worsening outlook for Latin American economies isn’t good news. Scandal-plagued Stanford Financial left 90,000 square feet behind when it closed. Developer Tibor Hollo bought a 3-acre Brickell property for less than half the $70 million it fetched four years ago. The office vacancy rate is 15%. With trade falling, the industrial market is seeing the highest vacancies in five years. Retail is holding up.
Broward: The market has $147 million in distressed office property. Industrial vacancies have risen for 12 quarters, while one north Broward property sold for 55% of its 2005 price.
Orlando: With an overall 17.4% office vacancy rate, rents are stabilizing. The airport market is strongest. The industrial market, dependent in Orlando on storing retail goods and building supplies, is seeing the worst vacancies in a decade. The industrial vacancy rate was 14.3% in the second quarter compared to 9.5% the year before. The retail vacancy rate was up to 8.4% last year.
Palm Beach: At 22.5%, Palm Beach County has one of the highest office vacancy rates in the nation. Two new office buildings in Boca were completed empty. The industrial vacancy rate is 11.9%.
Tampa Bay: Being the back office for national companies works against the Bay area in an era of consolidation. The Pinellas office market is faring worse than Hillsborough’s. In retail, community centers are doing the worst with a 9.1% vacancy rate. The industrial vacancy rate is 8.9%.
Jacksonville: A minor miracle in Florida commercial real estate: In the second quarter, rental rates in the industrial market were down only 7% to 10% for Class A space and more space was actually leased than vacated. Not so in other sectors. Bank consolidation hurts as shown by an overall office vacancy rate of 19.9%. The retail rate is 10.6%.
Source: Grubb & Ellis, CB Richard Ellis