50.7 F
San Diego
Monday, Jan 30, 2023
-Advertisement-

Residential Lending Crisis Trickling Down to Commercial Real Estate

BY SYLVIA TIERSTEN

The subprime mortgage crisis, which brought San Diego’s housing market to its knees, is casting a chill on the commercial office sector. Lax underwriting standards in residential real estate have sparked an across-the-board credit crunch, according to local real estate representatives.

“A lot of capital that was available for leveraged purchases is now sidelined or extremely cautious,” said Jonathan Ferrini, principal/director for Lee & Associates Commercial Real Estate Services in San Diego. “Deals are subject to increased underwriting scrutiny and more stringent appraisals.”

Since August, San Diego County has seen a significant drop-off in office building sales. Deals are taking longer to complete, and many have fallen out of bed altogether.

- Advertisement -

Louay Alsadek, executive vice president of the Investment Properties Group at CB Richard Ellis, estimates that “30 to 40 percent of the properties that hit the market have been taken off the market” and that the volume of activity in fourth-quarter 2007 was down 30 percent from a year ago. As for prices, he estimates they have dropped 10 percent during the past six months countywide.

“The meltdown over the summer caused a lot of deals to fall out of escrow,” said Steve Malley, vice president and managing director of Sperry Van Ness Commercial Real Estate Inc., University Towne Center/Carlsbad. “The debt market shifted on people while they were under contract , and they saw they couldn’t get debt where they thought they could get it.”

Missing in action from the current crop of lenders are Wall Street conduits that left the market when they could no longer find buyers for their pools of residential loans. “Those who were able to clear their books are back in the lending market, but their rates are significantly higher than where they were before,” said Mark McGovern, director of CBRE Capital Markets in UTC, the real estate investment banking division of CB Richard Ellis. He estimates the rate increase at half to three-quarters of a percentage point.

Cash is king in a market with fewer lending options. “Highly leveraged investors have exited the market,” said George Gramm, vice president of research at Grubb & Ellis|BRE Commercial in the UTC office. The emerging universe of buyers with a long-term perspective includes large institutions such as insurance companies and private investment groups seeking all-cash deals for well-located properties with creditworthy tenants.


Office Sales Slip

Meanwhile, office condominium sales have slowed to a crawl. “The fuel for these sales was coming from residential home values,” said Malley.

Financing offered by the Small Business Administration for an office condo requires a 10 percent down payment, which buyers typically extract from the equity in their home. Now that housing values are on a downward spiral, “people are nervous that office values will come down in lockstep with the residential market,” he said.

On the investment side he is seeing a flight to quality. “People are going to A locations and (Class) A properties, because there is more risk associated with C tenants in a down economy,” said Malley.

Nationally, cap rates are projected to rise in 2008, according to a year-end industry report by Pricewaterhouse & #173;Coopers and the Urban Land Institute. (A capitalization rate or cap rate is the ratio between the cash flow produced by a property and the original price paid to own it.)

“Lower cap rates mean higher prices on buildings,” said Gramm, who anticipates a modest correction in San Diego’s current 5 percent to 6 percent ratios.

However, with defaults on commercial properties all but nonexistent, “nobody is predicting huge drops in prices,” he said. Faced with fewer buyers who are willing to pay the seller’s asking price, some owners will opt to keep their property off the market for a couple of years.

“It’s not like 2006, when you might have five offers for your property and you could pick the most qualified one to enter into escrow,” said Mark Brady, vice president of major accounts at the San Diego office of Chicago Title. “Now you have to take what you can get.”

But so far, he noted, “Prices are not coming in below or drastically below the asking price.”

“The fundamentals are sound,” said Alsadek, citing the county’s diverse economy and resilient business culture. “It’s not like the 1980s when defense was the major player.”

He pronounced the county office market “still healthy,” with 55 million square feet of leasable office space, a historically low foreclosure rate, a 14 percent vacancy rate, and positive net absorption of 54.7 million square feet in 2007. “Leased space helps people carry their assets,” said Alsadek. “They don’t have to sell right now if they don’t want to.”

Although some homebuilders and financial firms recently closed their doors, major law firms in the Del Mar Heights area and some defense-related companies are in an expansion mode. Qualcomm Inc., Amylin Pharmaceuticals Inc. and Ohio-based Cardinal Health continue to gobble up more space. In Del Mar and Del Mar Heights, with low vacancy rates, high value-per-square-foot and limited new supply, “there is a good possibility for rental increases,” said Gramm.

“The strongest areas remain University Towne Center, the downtown area and Carmel Valley,” said Ferrini. “Investors there have the staying power to ride a buyer’s market out.”


Climbing Vacancy Rates

Elsewhere, owners face dicier odds. In Carlsbad, for example, vacancy rates are at about 25 percent and still climbing, said Malley.

“Investors who overpaid for office properties expecting to raise rents may be in for a rough patch as the economy pulls back and a glut of new deliveries hit the market,” said Malley. “They will likely have to revise their pro forma numbers downward.”

Surging defaults in the residential market, a plunging stock market and weak consumer spending are causing economic jitters among office tenants as well as their landlords. Some businesses are downsizing, while others are hesitant to take on new space.

“Everybody’s worried about the R word , recession , and whether it’s going to happen,” said Malley. “The subprime meltdown has caused everybody to pull back on the reins, catch their breath and say: “Where are we in this economic cycle, and as a business are we in a position to expand?”

Buildings that house construction and mortgage-related businesses are particularly hard hit.

“Real estate companies are closing offices and consolidating their agents. Approximately 40 percent of mortgage originators have left the business,” said Mark Goldman, who lectures on real estate, finance and investment at San Diego State University.

Another casualty of the subprime fallout are entrepreneurial startups seeking access to capital. Sources of credit such as home-equity loans, second mortgages or refinancing of a primary residence are not so easy to tap anymore.

“This diminishes the demand for Class B, Class C and flex-condo space,” said Goldman. “Higher vacancy rates and lower rents reduce the anticipation of future cash flows, which reduces property values.”


Sylvia Tiersten is a freelance writer based in San Diego.

-Advertisement-

Featured Articles

-Advertisement-
-Advertisement-

Related Articles

-Advertisement-
-Advertisement-
-Advertisement-