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Commercial real estate failures are easier to spot than residential woes
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Ann Strain walks Junebug, a Boston terrier, past a ghost town – hundreds of abandoned apartments with broken windows and weeds.
Neighbors think squatters have lived at times at the Signature Pointe apartments on Lovers Lane, just east of North Central Expressway. The Dallas police SWAT team trains there.
The apartments were emptied of tenants at least 2 ½ years ago to make way for new rental units and retail, but that never happened. Now a bank owns the 13 acres.
"It's pulling the value of the neighborhood down," said Strain, a condo owner who has lived across the street for 10 years. "I've seen lights at night, but I don't know if it's cops or crime."
Neighbors' concerns are an invisible consequence of landlords and investors across the country being unable to make their mortgage payments or secure new loans on commercial property that ends up foreclosed or forfeited to a bank.
Skeletons of unfinished buildings, weed-infested vacant lots for projects that never got off the ground and for-sale signs are the more visible remnants of an overextended commercial real estate market caught in the jaws of the biggest financial crisis and economic downturn since the Great Depression.
Debt-related project delays, failures and foreclosures have touched the lives of many North Texans. Contractors have closed, displacing thousands of workers. Unfinished construction and empty lots have created neighborhood blight. Americans with pension funds invested in real estate have seen smaller retirement nest eggs. Lower property values and taxes have meant less revenue for local governments, resulting in cuts to public services such as parks, libraries and law enforcement.
Banks have become unwilling to risk making loans needed to start construction projects. And that limited access to credit has frozen development.
Only five major U.S. metropolitan areas had more distressed commercial real estate than Dallas-Fort Worth's $4.3 billion through the first half of this year, according to Delta Associates and Real Capital Analytics.
Nationally, distressed loans on office buildings, apartments, retail stores and warehouses totaled $170 billion. Despite recent signs pointing to an improving commercial real estate market, those numbers are expected to increase.
The more than $1.4 trillion in commercial mortgages coming due this year through 2014 will be difficult to refinance and could derail economic recovery.
"It's the silent thing out there that everyone talks about," said Dan Busch, president of Structure Tone Southwest in Dallas, one of the area's biggest general contractors and one with no debt. "We all understand that it's a big system and we're all tied to it."
Ann Saegert, a partner at Haynes and Boone in Dallas who specializes in commercial real estate law, said the greater danger is defaults on loans.
A new wave of defaults could trigger more property vacancies and more bank failures. Commercial mortgage defaults contributed heavily to the nation's 255 bank failures in the past 20 months, including six in Texas, with more than $37 billion in losses. A congressional panel projects that bank commercial mortgage losses could hit $300 billion.
Giddy economic times and easy access to credit in the early 2000s led to a shopping spree, with buyers paying top prices for commercial property before and during the 2006 market peak. Lenders financed 80 percent or more of purchases.
Then in 2007, a home mortgage crisis triggered a recession and led to business failures and high unemployment.
Commercial real estate owners soon found themselves in a situation similar to many homeowners: owing more than their property was worth as values toppled more than 40 percent.
Many landlords couldn't generate enough cash flow to cover their debt payments as high unemployment weakened demand for office, retail and warehouse space and fewer travelers hurt hotels. Several Dallas developers lost bank financing and big-name tenants they had lined up. Those borrowers defaulted on loans.
In other cases, borrowers couldn't refinance loans coming due or loans where the value had fallen drastically. They faced foreclosure or forfeited their property to the bank.
"In the '80s, we overbuilt the market by a five- to 10-year supply," said Michael Ablon, principal of PegasusAblon Properties in Dallas. "During the dot-com era, tenants over-leased the market. In this era, we over-financed the market. The question is, can real estate kick the can long enough for the economy to catch back up?"
The health of the commercial real estate sector is crucial to the national economy, even if it's not as large as the residential market. U.S. commercial properties are worth $4.9 trillion, with $3.3 trillion of debt. The industry supports 9 million jobs.
D-FW commercial foreclosures have increased steadily since 2006, more than doubling to 2,431 last year, according to statistics from Foreclosure Listing Service Inc. in Addison. So far this year, foreclosure postings jumped 51 percent, to 2,541, from the same period a year ago.
Still, regional foreclosure postings aren't even close to the more than 7,000 at the peak of the late 1980s, said George Roddy, president of Foreclosure Listing Service. He has noticed a shift locally: The biggest surge in foreclosure postings this year is on buildings occupied by small businesses, compared with office and retail properties last year.
So far, the posh Four Seasons Resort and Club in Las Colinas, with $183 million in original debt, ranks as the largest North Texas foreclosure in more than two decades. Lenders bought the property – complete with a golf course, conference center and spa – at a June foreclosure auction for $122 million.
Foreclosure numbers don't portray a complete picture because they exclude certain properties, such as Far North Dallas' Valley View Center, whose owner recently handed over the shopping center to its lenders.
Other notable local foreclosures or bank forfeitures include bankrupt Nortel Networks' building in Richardson, the Park Lane retail and residential development near NorthPark Center in northeast Dallas and the Stoneleigh condominiums in Uptown.
Banks and the commercial mortgage-backed securities market fueled most of the growth in commercial real estate debt in the last several years, but both of those debt sources are anemic today. Commercial mortgage-backed securities are mortgages on commercial property that are bundled and sold to investors.
U.S. commercial mortgage-backed securities plunged to $3 billion in 2009 from a peak of $230 billion in 2007, according to Commercial Mortgage Alert. As of July, $2.4 billion in such securities have been issued this year.
Today, lenders are apt to "extend and pretend" – pushing back a loan's due date for a year or so to avoid taking a loss and betting that future conditions will improve enough so borrowers can pay down the loan or market prices rise. Since last fall, federal regulators have encouraged banks to do that as well as negotiate loan terms with borrowers and make new loans to help jump-start the economy.
"Lenders have put off construction loans and commercial mortgage foreclosures ... because of the gap between market prices for distressed real estate and the value of that real estate on bank books," said Matthew Anderson, managing director of Foresight Analytics, a real estate market analysis firm. "Some banks are purposefully not foreclosing on or selling commercial real estate on their books so they don't have to write off the loans as full losses."
Such short-term fixes can hide the true risks and pile up potential problems in the next few years. It's estimated that 60 percent of all maturing commercial debt is rolled over each year through 2012, compared with 15 percent in 2008.
Of the more than $1.4 trillion in commercial mortgages coming due through 2014, nearly $900 billion must be paid in the next two years, according to data from Foresight Analytics and Trepp, a real estate research firm. Banks hold 55 percent of that debt, institutional investors and others hold 27 percent, and commercial mortgage-backed securities account for 18 percent.
David Wyss, chief economist for Standard & Poor's, said fears about commercial real estate debt are overblown.
"There were some people feeling it's the end of civilization as we know it," he said. "This is a severe recession for the commercial real estate market, but it's still not like the residential real estate market."
The nation's $10.7 trillion in home mortgages outstanding in the first quarter of this year was three times as much as the $3.3 trillion in commercial mortgages. In addition, nearly $13 billion in commercial mortgages was more than 90 days past due in the first three months of this year, compared with $98.7 billion in residential loans, according to the Federal Deposit Insurance Corp.
Still, there's no mistaking the unfinished high-rises and empty lots dotting the North Texas landscape. Many real estate developers contacted for this story didn't want to discuss their failed projects.
Fairfield Residential, original owner of Signature Pointe apartments, didn't return phone calls.
Last fall, BBVA Compass took ownership of the complex from San Diego-based Fairfield, one of the nation's biggest apartment developers, which filed for bankruptcy in December. Fairfield CEO Christopher Hashioka said at the time that "the unprecedented collapse of the U.S. real estate and capital markets has made it difficult, if not impossible, for Fairfield to continue without restructuring its financial obligations."
BBVA Compass, which had loaned Fairfield more than $19 million in 2006, declined to comment.
Other lenders have foreclosed on properties, including the Mosaic apartments in downtown Dallas, after failing to reach new loan terms with the owners.
In 2007, Dallas-based Hamilton Properties turned a formerly vacant high-rise into the 440-unit Mosaic apartments – with rent as high as $7,000 a month and amenities including a pool, gym, cafe and restaurant.
In May, Prudential Commercial Property Holding Co. foreclosed on the building's $48.5 million loan balance.
Developer Ted Hamilton declined to comment for this article. In a February interview when the Mosaic was posted for foreclosure, he blamed a change in loan terms, an oversupply of downtown luxury residences and a lack of demand.
The company, which also developed the Aloft hotel, Davis Building lofts and DP&L Flats, all in downtown, made interest-only payments for the first three years of Mosaic's mortgage, but last year payments increased to the tune of $80,000 more a month, he said.
Smack in the middle of Craig Ranch in McKinney sits a half-empty, $52 million apartment and retail complex called Times Square. It's the first and only commercial foreclosure for the 2,200-acre development, which includes homes, shops, offices, a golf course and a hospital.
Developer David Craig didn't own or develop Times Square, but he's had to answer questions about the health of Craig Ranch.
"I wouldn't be honest if I said it didn't impact us. It is a trophy property right in the heart of our community," said Craig, who began the development 10 years ago. "The general public thinks Craig Ranch is the owner. Residents have asked me, 'Is Craig Ranch going to be all right?' "
Yes, he says, Craig Ranch, which carries no debt on its land, is fine. Bank of America sold the Times Square property last week.
"It's just not something I want to talk about," said Steve Everbach, one of the original owners of Times Square. "We were a small firm. The firm has closed and we've moved on."
The local commercial real estate market is seeing increased leasing, rising property values and more buyers. Private investors sitting on billions of dollars are ready to swoop down on bargain properties.
Equastone recently restructured more than $300 million of debt on nine Dallas-area office buildings with GE Capital a month before it was due.
The agreement extended the loan's due date by at least two years and provided additional funding to renovate buildings and make other changes to increase leasing, said Equastone CEO Kirk Cypel. San Diego-based Equastone, one of Dallas' largest suburban office building owners, is also looking for new investors.
Experts, however, warn not to get too excited about an industry turnaround, given volatile prices, slow sales, high vacancies and tough financing.
Standard & Poor's Wyss said commercial real estate is a lagging indicator, so the worst might not be over.
Others contend the commercial real estate industry can't fully recover without more job growth. More than 1.7 million of the 15 million people out of work nationally are construction workers, creating a 20 percent industry unemployment rate – more than double the overall rate.
It's a domino effect. Companies are reluctant to hire until they get a clearer picture of their tax, energy and health care costs. Until then, office vacancies will remain high and unemployed workers won't spend as much.
While the nation continues to lose jobs, Texas has added 181,500 jobs this year through July, including 30,700 in the D-FW area, according to the U.S. Bureau of Labor Statistics. D-FW gained 2,300 construction jobs in that time, but the 158,000 total was 6.5 percent less than a year ago.
Texas accounts for more than half of the 10 largest upcoming construction projects in the South, valued at about $15 billion. That includes the $2 billion second phase of the Dallas Logistics Hub in southern Dallas County and the $1.2 billion Dallas/Fort Worth International Airport terminal redevelopment.
Still, skepticism lingers.
"What's next is the question we're all asking," said Structure Tone's Busch. "You're starting to see some of the right indications, but is it enough?"