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Facing uncertain times, commercial real estate execs make changes
By Steve Row
Tom McMahon says the current economic crisis is a wonderful lesson in civics and economics for his school-age daughter.
As commercial real estate vacancies increase and rents decrease, "we are going back to the old basics of supply and demand, pure and simple."
No longer is a property owner able to charge whatever he or she wants to charge, because no longer is a customer willing to buy or rent at a price other than what he or she can afford. The level of market equilibrium is coming down from a high plateau-a level some have criticized as being artificially high-and furthermore, financial institutions are much more cautious about risking money in loans to highly speculative projects.
"This is a market dynamic that we've not seen before," says McMahon, managing partner of Sperry Van Ness/McMahon & Associates, a commercial real estate development and leasing firm with offices in Cornelius.
A sampling of Golden Crescent business leaders involved in commercial real estate shows that while the region has not been affected as adversely as other regions of the country, they are making changes in the way they do business.
The banker
Money is not flowing as freely toward speculative commercial projects, says Dan Williams, president of Farmers & Merchants Bank in Salisbury, and "we are being more cautious. Things have definitely tightened up.
"Things have not shut down, and we are still lending, but obviously we are being more selective. And we are not seeing as many deals now, especially speculative deals," he says.
Developers themselves are more cautious, too, he says. Developers now seem to have more space committed in their projects before seeking financing.
"In the past, we might do a project with very little space leased. A year ago, we would require 50 to 60 percent of the space to be leased. Now, builders and developers are looking at that figure before they proceed and seek financing," Williams says.
Other changes he has noticed in the commercial real estate market:
o Builders are scaling back on the size of projects, although most of the projects F&M is considering still are considered higher-end, with high-quality tenants.
o Lower-end projects are not being planned as often as in the past.
o Even build-to-suit projects-those committed in full or almost in full to specific tenants-are drawing more scrutiny and careful analysis from lenders than before.
Williams describes the current Golden Crescent market by segment as follows:
o Some demand for new retail space, but not as much as a year ago. "Builders are still convinced they see a need in this market, because this market is not slowing down as much as the economy in general." However, as a bank, F&M now might be "more comfortable" lending for a retail project that is 75 percent leased before construction, for example, Williams says.
o Virtually no demand exists for new industrial space, although F&M began reviewing a proposal for a high-end project in Concord that a well-known developer is planning.
o Demand for new office space has "slowed down but not stopped."
o Demand for new medical facilities might be the only segment that remains relatively strong. Competition to serve patients in the area between Charlotte and Salisbury "is fierce, and these projects are not as speculative in nature. By the time they are finished, they are pretty much all leased up," Williams says.
The contractor
Daniel Andrews, vice president of business development at Granger Construction Co. Inc. in Mooresville, describes his firm's business, and the contracting business in general, as "a mix of postponements and some projects moving forward."
He says project owners who were optimistic earlier in the year about their prospects turned less optimistic by the summer, and now they are more pessimistic.
"We've seen projects, especially offices, put on hold because of a lack of tenants," Andrews says. "There are a lot of vacant buildings, some Class A, some Class B, here."
Non-residential construction in the entire Charlotte region, stretching from the Golden Crescent into York County, S.C., actually showed a healthy gain in September, according to the F.W. Dodge Division of McGraw Hill Construction. The value of construction permits for the month was $163.8 million, up 25 percent from $130.9 million in September 2007.
But for the year-to-date, non-residential permit activity declined 27 percent to $1.498 billion from $2.065 billion in the January-September period of 2007.
Andrews says his firm is making adjustments to counter the current conditions, among them:
o With the number of projects slowing down, Granger has "broadened the type of project we would look at doing. Some are slightly smaller than those we were doing a year ago," he says.
o Cost containment is more important than ever before, because building materials are more expensive than they were a year ago. Copper and steel prices "seem like they are going through the roof," he says.
o Marketing efforts by the firm are increasing. "We've spent more time at conventions and trade shows, and we are meeting more often with local businesses," he says.
Andrews says Granger has maintained a relatively stable work force and steady work load throughout the year. The firm has 18 salaried employees in the main office, along with eight superintendents in the field and a number of hourly employees. The firm is principal contractor for several projects in the region, as well as for movie theaters being built by repeat clients in Kentucky and West Virginia.
However, the current economy is putting a squeeze on the construction business, "and more people are dropping off resumes. Earlier this year, we hired a couple of new people, and the number of resumes we had for those positions was much higher than we had a year ago," he says.
The real estate broker-manager
What is now being experienced in the commercial real estate industry because of turmoil in the national economy is confusion, according to Tom McMahon of Sperry Van Ness/McMahon & Associates.
"We're waiting for the next president. We're waiting for the new direction that the country will be going. I think you'll see confusion settling down after the election, which will give us some direction, but we're not going to get back to where we were two years ago any time soon."
McMahon says several problems continue to plague the commercial real estate market in general-sellers are "over-leveraged," and "it's harder to get a deal to close because of obvious lending reasons"-and this is contributing to the uncertainty.
As a result, his firm is undertaking several steps to counter the obstacles in the current economy:
o Seeking opportunities to expand through acquisition. "The closings are not coming in like they used to, but we do have the opportunity to expand our business with the acquisition of other commercial real estate brokers," he says.
o Considering different kinds of deals, including foreclosures and bank-owned properties.
o Making more "cold calls" to gain prospective clients. "We're doing about the same level of marketing, but we're picking up the phones more," he says.
o Consolidating listings to eliminate those that are not priced properly.
o Growing the property management side of the business. "We've added some new accounts in this area in the past two months, and we are aggressively pursuing more," McMahon says.
Current conditions are leading to some new wrinkles in how the industry operates, too. Opportunists are coming out, in the form of "vulture funds," to buy up properties at lower prices, for example, and selling at auction properties that are built but not yet occupied (and not in foreclosure) is becoming a more common way of disposing of commercial real estate.
And, of course, more projects "are being put on delay because of financing, and because of the slower markets," McMahon says.
McMahon & Associates seems to be weathering the storm, however, he says.
"We are diversified enough so that we can sustain some of these problems. I can't say it doesn't hurt, but if things continue for the next couple of months as they have so far, we will close out 2008 above 2007," he says.
The real estate broker
Business in the commercial division of Newport Properties in Mooresville remained strong for a while earlier this year, even after things started to head south in the residential market, but now, amid the national economic turmoil, "we've seen some softness," says Bill Gaither, commercial division broker.
"The conditions in the national markets gave everyone a pause, especially in the availability of credit," he says.
From the perspective of one who represents both buyers and sellers in commercial real estate deals, Gaither says the difficulty in obtaining financing is the principal reason deals have been postponed or fallen apart, not the asking price by a seller or owner.
"I've not seen price as being the driving factor" in many failed deals, he says. "I've seen some properties priced too high, but if I have a serious buyer, I generally can find a suitable seller."
However, financial institutions "are asking for more equity from buyers, for instance. It used to be you could get your money with 10 percent equity; now it's 30 percent," he says.
And money for acquisition and development deals has become just about non-existent, Gaither adds.
Gaither says one possible advantage to being involved in the commercial real estate market, vs. the residential market, is that "there is no emotion in commercial real estate. It's purely business. It's not like residential property, because you don't have your kid's treehouse or basketball goal in the back of a warehouse."
This eliminates a hard-to-quantify factor that often plagues residential real estate transactions.
Gaither says he is always looking at the firm's business model to see if it needs a tweak here and there, but he has not made drastic changes in the way he is doing business.
"I'm always keeping in contact with buyers and sellers, and I'm always trying to meet and introduce myself to new prospects. I'm staying out in the community and not sitting at my desk," he says.
One area that is drawing closer scrutiny, however, is whether the client has the financing lined up, or is likely to obtain financing, before proceeding too deeply into the transaction process.
Gaither's business, which is concentrated mainly in the Lake Norman area, has its own set of considerations affecting commercial real estate transactions. Watershed rules, careful rezoning standards and a limited amount of land that can be developed commercially all come into play. The more rural the area, the less likely water and sewer service is available.
"But we think commercial areas still will grow, north and east of the area, especially when Mooresville is connected to the Concord and Kannapolis area, and as the Lowe's headquarters continues to expand."
The future?
"There is still a demand for commercial real estate lending. That's not gone by the wayside," says F&M Bank's Dan Williams.
"Builders are waiting to see a climate change, but it won't be for a while. I suspect that, given the condition of the economy and the health of the markets being what they are, we won't see better conditions until the second part of 2009, or about nine to 12 months out."
Andrews of Granger Construction expects some casualties in the construction industry before things get better.
"I think you will see firms laying people off in the near future. Fewer projects on the design boards mean fewer projects getting under way in the spring," he says.
McMahon of Sperry Van Ness/McMahon & Associates says the so-called 'word on the street" is that some commercial leasing brokers in the area are being laid off, or, if not being laid off, being put on straight commission, instead of salary and commission.
"I don't think the (federal) bailout has affected the markets yet. At least I've not seen that it's helping yet. But I see that for the balance of the year, we will continue to have a confused market. After the first of the year, we'll see more stability and better conditions, and by mid-year banking will get a whole lot better.
"I'm not totally pessimistic, but any time you have turmoil like this, you have to change, and we are making changes."
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