Construction Financing is Back But, As Developers Are Learning, Equity is Key
Jotham Sederstrom Feb. 14, 2012, 2 p.m.
Plenty of statistics point to the need for new office construction in Manhattan, and the city’s aging building stock isn’t least among them.
Indeed, no meaningful addition to the city’s roughly 400 million square feet of commercial space has been added to the skyline in two decades, raising questions as to whether it could face a shortage in the coming years, a situation that has pressured rental spikes in the past. For now, however, amid what appears to be at least a hiccup in leasing during the last quarter of 2011 and the opening quarter of this year—not to mention lingering concerns about the health of the economy—only the most intrepid developers have gone into the ground with projects.
Uncertain demand and other hurdles that developers must negotiate to build, including securing a site in a city where prime development parcels are both difficult and expensive to acquire, only partly explain the dearth of construction.
In the wake of tightened lending standards, construction financing remains hard to secure, and for developers who are able to source loans, the terms have shifted in a way that places far more of a project’s risk on their shoulders.
“We’re finding that for the right projects and sponsorship, there are lenders in the market who are willing to provide financing,” said Charles Bendit, a principal at Taconic Investment Partners LLC, a real estate investment and development firm that has built a number of buildings despite the challenging lending conditions in recent years, including the boutique office building at 15 Little West 12th Street. Mr. Bendit and Paul Pariser, another principal at Taconic, are in the process of starting 837 Washington Street, a roughly 55,000-square-foot office and retail property that, like 15 Little West 12th, is located in the trendy meatpacking district and will be built on speculation.
But Mr. Bendit pointed out that even developers like himself and Mr. Pariser, who have an impressive track record, have to front as much as 45 percent of the cost of a new building to secure financing, a far higher equity requirement than in the years before the recession hit.
“It used to be that you could get construction financing for 75 percent of a project’s cost,” Mr. Bendit said.
Developers must also submit to various loan covenants, terms they might have laughed at during the boom years, when money came with few stipulations.
“You’ll always have certain guarantees such as completion guarantees that you’ll finish the building,” Mr. Bendit said. “But now the lenders want more. There are guarantees that if you run out of interest reserves, you’ll pay the interest out of your own pocket. There are guarantees that if there’s a default and the lender has to take, say, a $50 million project and sell it for $47 million, you’re on the hook for the $3 million difference. These terms are all new.”
The tougher lending environment has forced developers to pour more of their financial resources into construction deals and also to bear more exposure to the consequences of how the investment performs.
John Lam, a prolific developer of hotels in the city, told The Commercial Observer that he may pony up as much as $200 million of the estimated $350 million cost of a large new hotel and retail complex he is planning to erect on 30th Street and Broadway.
“Financing is still very tough and most of it is relationship driven right now,” Mr. Lam said.
Mr. Lam said he is pulling money out of his large portfolio of Manhattan hotels by refinancing the properties in order to write the huge equity check for what will be his signature Manhattan development. Before the downturn, he would have likely been able to finance the project without having to involve his other assets. Although he is leveraging his holdings to do the deal, Mr. Lam also looks at the massive cash infusion as a way to gird himself against risk by lessening the debt payments he’ll have to make while he gets the 30th Street project up and running in the coming years.
“I don’t like to have a lot of leverage against a property when it’s not income producing,” Mr. Lam said, noting that his portfolio currently has low leverage and strong cash flow and that the planned refinancing won’t burden his hotels with undue amounts of debt.
Like Mr. Lam, other developers have plowed substantial funds of their own to get buildings started. In late 2010, Monday Properties, a real estate company with holdings in Washington, D.C., and Manhattan, began construction on a nearly 600,000-square-foot office tower at 1812 North Moore Street in the D.C. submarket of Rosslyn, Va. Unable to get a construction loan at the groundbreaking, Monday Properties financed the project with its own funds while searching for a loan. Over a year later, the company continues to pay for the planned $350 million construction out of pocket and said it will continue to do so if necessary through the project’s scheduled completion in late 2013.
“We’ll build it all equity,” said Anthony Westreich, the chief executive of Monday Properties. “We believe in the market and the site. We know that tenants will come.”
Mr. Westreich said that the North Moore Street tower he is building would be one of the best quality office properties in the entire D.C. region, a market that rivals Manhattan for its high office rents and occupancy levels and enjoys strong demand from government tenants. Still, the company’s commitment appears incredible compared to past years.
Behind the willingness of developers to persevere in spite of the trying lending market is a core belief that timing is on their side. Recent developments like 510 Madison Avenue and 11 Times Square were easily financed during boom years, but fell on hard times because construction started too late in the cycle and completed only after the market turned. By beginning now, just as the market appears to be heading back up, many developers feel assured that their projects will come online just in time to capitalize on strong conditions.
“My feeling is, if you show people pictures of what you’re building, they don’t believe you,” said Edward Minskoff, a developer who’s currently building one of the city’s largest and most anticipated spec office buildings, 51 Astor Place. “If they go down to my site, they’ll see 30 or 40 guys on the job, like little beavers working away. My eye doctor called me the other day and said, ‘I can’t believe you demoed those buildings and are starting.’ When you’re actually building, people know the difference, the project becomes real.”
Mr. Minskoff recently secured a $160 million construction loan for the 400,000-plus-square-foot office building, which he said will be finished next year. Mr. Minksoff told The Commercial Observer that the loan would cover between 60 and 70 percent of the project’s estimated cost, but declined to discuss specifics.
“The credit markets have changed significantly,” Mr. Minskoff said. “I remember in the early 1980s, I would have been able to get something like this 100 percent financed in a few hours by making a few calls. But in this case, we feel our timing is good.”