2010 expected to be a year of reckoning and investor opportunitiesDecember 29, 2009 6:00 AM
by Paula C. Squires
In 2010, the biggest game in commercial real estate may be the handling of distressed assets. Across Virginia, real estate investment and management companies have assembled asset-recovery teams to tap into an expected boost in business from defaults, workouts and foreclosures as banks restructure maturing loans.
Investors also are jumping in. A Richmond investment group recently put together $50 million and 45 partners from across the country to start a private equity fund. The sole purpose of E/Class MB Partners Fund I? To provide incremental capital and management solutions for distressed properties. Bryan Kornblau, a partner in E/Class and chairman of Eagle Construction in Richmond, says that by working with existing owners and lenders, the fund creates an asset plan to “pull a project out of the ditch.”
In its first deal, the fund plans to make an initial investment of $8.7 million in West Broad Village in Henrico County. Work on the $300 million mixed-used development had ground to a halt because of more than $5 million in liens and lawsuits. The infusion of capital should settle the litigation, allowing the project — in a prime corridor near Short Pump’s retail center — to move forward.
The fund is looking at opportunities throughout the mid-Atlantic. “Even preferred projects are starving for sources of capital,” says Kornblau. “We provide the capital to help the bank exit the asset without taking a huge haircut. That’s the difference between what we do and what vulture investors do. They’re looking to buy something cheap.”
Activity around distressed assets will boost transactional volume. “It’s going to be good for the brokerage community,” says Steve Gentil, chairman of Grubb & Ellis/Harrison & Bates in Richmond. “If a property was worth $150 a foot two or three years ago and someone buys it for $80 a foot, it’s still a transaction.”
But there will be plenty of pain to go around, too. If 2009 was the year of “pretend and extend” as banks put off dealing with overleveraged commercial loans by extending terms, 2010 is shaping up as the year when the hammer comes down. And lots of banks and borrowers could get clobbered.
Troubled commercial real estate loans figured in Virginia’s first bank failure last month. The Federal Deposit Insurance Corp. took over Reston-based Greater Atlantic Bank. “Both the commercial real estate loans that they made and the commercial real estate loans that they purchased played a role in the bank’s closing,” says David Barr, a spokesman for the FDIC in Washington.
By mid-year 2009, data gathered by the Richmond Federal Reserve Bank showed that nonperforming, delinquent commercial real estate loans (90 days or more past due) represented 8 percent of the total amount of commercial real estate loans in the portfolios of banks in the Fed’s five-state district, including Virginia. “What we’re seeing in the Fifth District looks pretty similar to national numbers,” says John Weinburg, senior vice president and director of research at the bank.
For the sake of comparison, the level is on par with delinquent loan rates banks saw in the early ‘90s — the last major downturn for commercial real estate. For construction and land development loans, the district’s non-performing loan percentage is even higher, 12 percent, notes Weinburg.
The Fed has characterized the risk of bank exposure to troubled commercial real estate loans as manageable. Yet, defaults are expected to increase as the first of more than $150 billion worth of commercial-mortgage-backed security loans comes due between now and 2012. The initial wave is expected by the second quarter.
Many property owners are finding it hard to refinance, because property values have plunged — by as much as 40 percent from 2007 market peaks in some markets. Consequently, some loans are underwater. This occurs when the value of the property being used as collateral on a loan is less than the debt owed.
Virginia has seen its share of foreclosures including the empty, 300,000-square-foot Circuit City corporate headquarters in Richmond. With U.S. office vacancy rates projected to rise to as much as 18 percent this year, it’s no wonder The Urban Land Institute predicts a “survival of the fittest” environment. In its annual industry survey, it looks for commercial markets to bottom out, paving the way for a protracted recovery that may not gain traction until late 2011 or 2012.
Virginia tends to weather market downturns better than many states because of a big federal government presence in Northern Virginia and Hampton Roads. Still, Gentil looks for the state to share in the coming losses. “A lot of the properties developed, acquired or financed from 2002 onward have too much debt,” he says. “The underwriting was too loose and the property was overvalued in the first place. A lot of commercial real estate wealth will evaporate in 2010 and 2011 in the region and the country. It’s unavoidable.”
Yet the new year also brings opportunity for cash-rich investors. “There is an unprecedented amount of institutional and private capital on the sidelines actively pursuing lucrative acquisition opportunities,” says Jay Sloan, an investment adviser with Marcus & Millichap in Williamsburg. Sloan’s firm recently closed a deal on a 300-unit, townhouse-style apartment community. The Townes at Jones Run in Newport News, a 23-year-old project that was recently renovated, sold for $23 million, slightly less than its current assessment. The buyer was an institutional investor from Virginia Beach.
Marcus & Millichap began to see an uptick in sales activity late last year. By October, the real estate investment firm had closed or listed $1.4 billion worth of distressed asset properties throughout its 70 U.S. offices, according to David Feldman, regional manager for the company’s Washington, D.C., office. “The real buyers are back,” he says. “It’s not just the vulture funds.”
Back in Richmond, John Gentry, who heads up a new asset-recovery initiative for Grubb and Ellis, said his firm was involved in a foreclosure sale that saw a Charlottesville group of investors buy an older 1,286-unit apartment complex for $24 million. The original loan amount was $52 million, he says. Multifamily projects tend to move well, adds Gentry, because buyers can still get financing through federal supported agencies such as Fannie Mae and Freddie Mac.
Real estate experts say the economy and unemployment will drive commercial real estate in 2010. If the economy keeps shedding jobs, the market will continue to see falling demand as businesses reduce and sub-lease space. Financing also remains a challenge. Some people think it will take some form of government intervention to replace the collapsed commercial mortgage-backed securities market.
While the big picture remains daunting, there are pockets of good news in Virginia. A short forecast on the major markets:
Washington, D.C./Northern Virginia
As always, Uncle Sam cushions this market. With the federal government expanding, many agencies are signing big leases. Plus, $5.5 billion in stimulus money is earmarked for public building services, from full-blown renovations to smaller jobs.
Still, there’s plenty of surplus office inventory. Speculative buildings are standing vacant from Southeast Washington to Dulles. By the end of the third quarter of 2009, one estimate put the region’s vacant office space at 14 million square feet. In 2010, D.C.’s vacancy rate is expected to hit 15 percent, according to a forecast by Jones Lang LaSalle.
While the area needs time to absorb the space, it’s still considered a top investment market. Jonathan Hipp, president and CEO of Calkain Cos., a real estate investment firm in Reston, says his company got its highest retail price ever in September for a ground-floor retail condo in D.C.’s Logan Circle Metropole building. The 550-square-foot condo sold for $1,123 per square foot to an independent private investor. “Even in a market like this, people will stretch for good real estate,” says Hipp.
A strong military presence buoys this market. In October, unemployment was 6.5 percent, well below the national average. Demand continues for office space in the medical and education sector, says Gerald S. Divaris, chairman and CEO of Virginia-Beach based Divaris Real Estate Inc. He’s also seeing more movement in retail. “Retailers that weren’t doing much have now released us to look for space.”
One area of expansion is The Town Center of Virginia Beach. It expects to break ground on a new hotel-office project in 2010. Norfolk also will get a new 23-story office tower that will house a new regional headquarters for Wells Fargo.
Marketwide, commercial vacancy rates stood at about 12 percent by year-end. The area has taken some hits in the industrial sector, with the loss of a Ford truck plant in Norfolk and the expected closing of International Paper’s plant in Franklin.
Compared with 2009 when the region lost three of its major employers, brokers are looking for a better 2010. Some companies saw an uptick in leases in the fourth quarter, particularly among smaller spaces. A couple of larger deals, such as BB&T’s 140,000-square-foot lease at Riverfront Plaza, help set the stage for optimism.
Overall, office vacancy rates hovered at nearly 12 percent for Class A space by year-end. 2010 will remain a tenant’s market, with businesses demanding competitive rents and improvements. Jay Kraft, vice president for the Richmond office of Liberty Property Trust, expects a slow recovery, as the market take times to absorb the space dumped by former employers such as Circuit City Stores, LandAmerica Financial Group and Qimonda.
This up-and-coming market was busy enough even in 2009 for one real estate company to add four brokers. Dennis Cronk, president and CEO of Poe and Cronk Real Estate group, says his firm added staff to keep up with business. He says national retailers are going into six new locations in Roanoke, the New River Valley and Lynchburg.
On the office side, much of the leasing is coming from the local, state and federal governments. The Social Security Administration just opened a new 65,000-square-foot office in Roanoke. “We’ve managed to keep things moving, and I’m cautiously optimistic for 2010,” says Cronk.
A lot of his recent business has been in distressed assets. “We’ve had a cadre of investors who have been sitting back and waiting for the opportunities to purchase assets that have good value. I’ve sold vacant industrial buildings, vacant retail buildings and vacant mixed-used buildings.”
There are no comments for this entry