HOUSING MARKET AND THE REAL ESTATE BUBBLE

[sumisu]

New wave of commercial foreclosures looms

STAFF PHOTOS / E. SKYLAR LITHERLAND Buy photo

Orion Bank foreclosed on the Pan American Professional Center in North Port in January.

By Michael Braga

Published: Sunday, October 25, 2009 at 1:00 a.m.
Last Modified: Saturday, October 24, 2009 at 9:53 p.m.

http://www.heraldtribune.com/article/20091025/ARTICLE/910251027/2107/BUSINESS&tc=email_newsletter#


Land at 5150 N. Tamiami Trail near the Sarasota-Bradenton International Airport was to be developed -- until the developer defaulted on the loan.


Banks have foreclosed on more than 400,000 square feet of office space, more than 400 hotel rooms, more than 1,250 condominum units, more than 100,000 square feet of warehouse space and more than 150 acres of raw commercial land in Sarasota and Manatee counties since November.

This is prime commercial real estate that about 80 investors bought and developed during the real estate boom with loans totaling nearly $300 million.

With those investors unable to make interest payments, the properties will soon be taken over by banks -- a prospect that few in the financial community look forward to.

Just as the housing market starts to recover and the national economy tentatively emerges from the deepest recession since the 1930s, banks across the country are bracing for another wave of foreclosures.

Nationwide, $1 trillion in commercial real estate loans comes due next year. Many borrowers are unlikely to be able to refinance, causing defaults that could lead to more bank failures and could even knock the economy back into recession.

The only hope of averting a wave of defaults: a resurgence of investor buyers. Most observers think those buyers are waiting for fire-sale prices before they jump in.

Paul Kasriel, Northern Trust's chief economist, predicts the new wave of foreclosures means the growth the U.S. economy saw in the third quarter will not be matched again until the last quarter of 2010.

"This tsunami will not be as big as the first one," said Kasriel, meaning the wave of residential foreclosures. "But it will wash over the financial system and cause a lot of damage."

Office and hotel defaults

The big office complex that Peter Shipps erected on Tamiami Trail in North Port is a symbol of overbuilding during the boom.

Thinking that Southwest Florida would benefit from a sustained population increase, bankers willingly lent money without developers having to pre-lease the space.

Shipps, a successful Venice builder and developer, approached Naples-based Orion bank with a plan to build five Class A office buildings. Orion lent him more than $10 million for the first phase.

But just as Shipps' first two buildings came out of the ground, the real estate market entered its prolonged slide. He was unable to lease enough space to make interest payments and defaulted on $7.3 million in January.

"They are great buildings in a great location," said Chad Maxwell, a North Port commercial real estate agent. "They just created too much space on the market."

The worldwide recession only made things worse, said Stan Rutstein, a commercial agent with Re/Max in Bradenton.

"Every doctor's office, every attorney's office, every imaging center and every dentist's office cut back," Rutstein said. "People have left the market, tourism is down and businesses have cut back staff. It's pretty bloody."

A large of amount of office space built is sitting empty. Vacancy rates hover around 14 percent in downtown Sarasota, 20 percent in Lakewood Ranch and 30 percent in Venice and Bradenton, according to Manatee and Sarasota counties' economic development organizations.

The fortunes of local hotel developers also plummeted.

In 2005 and 2006, there was a mini-boom in hotel acquisitions and developments. A group led by Harvey Birdman paid $10 million for the 178-room Holiday Inn on Tamiami Trail near the Sarasota-Bradenton International Airport in April 2005. Reliance Realty Partners out of Stamford, Conn., invested more than $30 million in a vacation rental and marina project on Holmes Beach. Bernard LeBlanc's family bought the 160-room Holiday Inn on the U.S. 41 bypass in Venice for $10 million in August 2006.

All three have since defaulted, on more than $50 million in loans.

Another beat-up segment is office condominiums.

During the boom, these 1,000- to 2,000-square-foot spaces sold as fast as they came to market at ever-increasing prices. Condos that started selling for $55 per square foot soared as high as $155, said Carl Wise, a commercial real estate agent who founded Sarasota's Preferred Commercial.

But their owners are now defaulting in large numbers.

"They're in a terrible place now," Wise said. "They are losing their shirts and will continue to do so."

Banks swamped

Banks that lent money to commercial developers and investors are suffering along with their customers.

"I talked to one banker back in June and he said he had a stack of foreclosures two feet thick in his office," said Jeff Button, a commercial agent with the Sarasota's Kleiber Group. "And that's just one bank."

Analysts expect Florida community banks to be hit especially hard because they tended to make a lot of commercial property loans. Southwest Florida already has seen five banks go under -- Bradenton's Flagship National Bank, First Priority Bank and Freedom Bank and First State Bank of Sarasota and Community National Bank of Venice. They may not be the last.

In the meantime, the problems will be felt in the broader economy.

Banks have the capital to make loans. It just makes no sense to chase after commercial real estate when values are dropping, said Bill Sedgeman, chairman of Community National Bank of Manatee.

"What's coming to us now are people who are underwater on their mortgages," Sedgeman said. "They owe more than the properties are worth."

The only way banks can refinance them is if customers are willing to bring cash to the closing table.

Their properties are now sometimes worth only a third of the value they had when the loans were made, so they will have to repay some of what they borrowed. But few borrowers can come up with the cash. So banks will have to foreclose and sell off the properties.

With more and more properties coming onto the market through foreclosures, commercial property values will continue to drop.

Until buyers start taking more properties off the market than are coming on, banks will not lend, Sedgeman said.

"We need to have buyers and we don't have buyers," Sedgeman said. "The reason we don't have buyers is that our economy is so construction-oriented. Until construction gets started again, we won't have jobs and without jobs there will be no tenants for commercial space."

Awaiting private investors

With banks out of the picture, cash-rich private investors and private equity funds will rule the day.

But those investors are unlikely to buy until prices fall to 10 to 20 cents on the dollar, said Rutstein, the Bradenton agent. That is when the powerful private equity money from the Related Companies, Steve Roth of Vornado Realty Trust and Granado Real Estate will get involved.

"Buyers are not going to adjust prices," Rutstein said. "There's no reason. There's more supply than demand and every week supply gets bigger. The most used word in commercial real estate these days is 'carry.' 'What will it cost me to carry this property and for how long?' These are unknown questions.

"The price has to be right and we really haven't come to terms with the right price at the moment."

Generational wealth

The only good to come of all this turmoil: "People who have money will be able to create generational wealth," said Chad Maxwell, a North Port commercial real estate agent. "They will be able to buy properties for far less than the cost of construction."

In Southwest Florida, the residential market will gradually strengthen, allowing home builders to begin construction again. As the economy improves elsewhere, retirees will show up in greater numbers. Those builders and their subcontractors will expand staff. Offices and warehouses will start to fill. The growing population and rising employment will boost consumption.

Once all that happens, commercial real estate lease rates will stop falling, analysts said.

But how long will it take?

"In the old days, you could make a reasonable guess," said Ian Black, a Sarasota-based commercial real estate broker. "Even now, investors are willing to come back in the market. But there is still a tremendous gap between what people are willing to pay and what banks will let properties go for."