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Housing troubles resonate in commercial market as lenders set higher rates

Frank Norton, Staff Writer

Lenders wary of deepening woes in housing are reacting by raising the cost of financing deals for hotels, offices and other uses.They’re resetting terms for projects with higher interest rates and more stringent requirements. In some cases, they’re walking away from deals altogether, leaving borrowers with void commitment letters and unrefunded deposits.

While the reaction is hardly the clampdown seen in subprime mortgages, it’s still enough tightening to slow the brisk march of commercial real estate markets, which have enjoyed falling vacancies and rising rents in the past three years. The reaction also could dampen commercial property values as higher financing costs cut the number of buyers.

The sky is not falling, but things could get worse, commercial real estate experts say. Many see the Triangle in a better position than the nation as a whole because of strong population and job growth, both of which boost demand for offices, apartments and other commercial space.

But even local markets should feel the financing squeeze. And it’s coming from two sources.

First are so-called portfolio lenders. These are often insurance companies that buy and hold real estate debt for long periods. They’re increasingly leery of commercial real estate exposure and are backing away.

Then there are “conduit lenders,” who buy commercial real estate loans and repackage them for sale as debt securities on secondary markets. These resellers are seeing a drop in demand from bond investors to whom they are unable to pass on their debt.

“There is about $50 billion in commercial mortgage securities sitting on the shelves because it can’t make its way through the system,” said Bob Hukill, CEO of BB&T’s Laureate Capital, a commercial mortgage brokerage based in Raleigh.

Mortgage brokers say the housing market credit crisis that has rippled across financial markets has also muddied investment waters in commercial real estate and made it difficult to price risk. As a result, “people are sitting out,” Hukill said.

Origination of commercial real estate loans for resale on secondary markets should fall about 75 percent during the second half of this year. That’s according to researchers at Wachovia Capital Markets who issued a report last week saying that lenders are scrutinizing deals more closely, postponing or canceling closings and, in other cases, “kicking out more loans” from their investment portfolios.

These changes will most affect heavy borrowers, but various investors may have to drop land acquisition or development plans midstream if financing becomes too expensive. That means fewer property sales and new developments, both of which have ramped up substantially in the Triangle, said Jim Anthony, a commercial real estate broker in Raleigh.

Through June 30, investors had spent at least $1.1 billion on offices, warehouses and apartments in the Triangle — a third more than the 10-year annual average, according to figures from CB Richard Ellis.

Anthony said pricier commercial mortgage costs ripple out to the broader economy. Hotel and apartment developments planned for downtown Raleigh could raise room rates and rents to cover higher financing costs. Similar pressures have halted the development of subdivisions in Wake, Durham and Orange counties, he said.

While the credit crunch is a painful adjustment for some, it’s also a healthy correction for the broader market, experts say.

Financing will get pricier, “and indeed it should,” said Gregg Sandreuter of Hamilton Merritt. The downtown Raleigh condo developer said cheap money fueled deals and elevated values in recent years.

“What we have now is a revaluation of risk and asset values,” Sandreuter said.

He said higher borrowing costs in the future may make it harder to finance further commercial property development, such as the recently demolished city block directly east of the construction site of RBC Centura’s future headquarters in downtown Raleigh.

“Some deals aren’t going to get done, and others will get recalibrated, and that’s good,” he said.

But longer term, the local market should remain fundamentally sound as long as business growth continues to underpin leasing and new construction, Hukill said.

“The fundamentals are strong, Hukill said. “Yes there’s a liquidity crunch, and that’s a problem. There’s no question we’re all being hesitant. But it’s not like we are overbuilt or that our properties aren’t operating well. Apartments are full, shopping centers are full, and people are making their payments.”

Staff writer Frank Norton can be reached at 829-8926 or frank.norton@newsobserver.com.