The Real Deal New York

Developers afraid to break new ground

Projects starting up in '08 will be rare, developers say

April 01, 2008
By Melissa Dehncke-McGill

Lenders looking for a reason to call in defaults? Banks showing up at closings without any money? Fire sales on newly built condos? These are just some of the grim realities that New York City developers are dealing with in this less forgiving economic terrain. Developers interviewed for The Real Deal’s Q & A offered up blunt assessments on lending standards to their novice counterparts (“they are done”).

In addition to the stories of lenders searching for reasons to call in defaults, banks pulling out of deals they have already offered letters of intent for, and planned projects that will not see shovels hit the ground, developers said projects slated to start up in 2008 will be virtually nonexistent. “Everything coming up now is a ’09,” said Daren Hornig, managing partner at SAXA.

Some developers said they are getting regular phone calls from lenders and investment banks asking if they’re willing to buy or partner on existing projects with smaller developers. Others said they expect the number of new condo developments to fall by 20 percent a year for the next five years and for Wall Street buyers to increasingly be replaced with lawyers, accountants, artists, brokers and other professionals.

Still, they said there are opportunities to be had. One developer said his firm would be buying up distressed projects and recapitalizing them to finish construction. And there still are development deals that make economic sense, such as retail and rentals. Developers are also hoping the downturn will mean a drop in land prices, which will allow them to get more projects in the ground. For more, here’s what our experts had to say:

Miki Naftali president, Elad Properties

What is your outlook for residential development right now?

I think any developer should be careful with this market. The very high end of the market is holding very well. It will take 12 to 18 months for the market to get not to where it used to be, but to regain positive momentum.

Are developers shying away from starting new projects and focusing on finishing existing ones?

I think the answer is yes. Some just don’t have a choice. Only the strong players can get financing, so there is less development in the pipeline.

What is the most positive aspect of the new development market?

Based on the financial crisis, there is a decrease in development, and we are expecting a decrease in construction costs.

Any notable examples of deals you’ve seen recently that indicate where the market is at?

We are getting phone calls, almost on a daily basis, from lenders — both investment banks and mezzanine lenders — asking us to look at specific developments, either to buy or infuse equity into the deal. Clearly, the smaller developers are struggling right now.

What surprises you most about the new development market right now?

The land price is still high, in my opinion, so I am expecting land cost to go down in the next few months.

As far as sales go, what segments of new development are the most active?

The very high end is very strong, and I would say most or all high-end brokers that I know are complaining that there is no product to sell. So any new development that can create a truly luxury product should be successful.

Which types of units are selling best?

The big units, especially, are selling best. But it’s not only about the size — it’s about the quality of the development and the quality of the unit. For the $5 million-and-up type of buyer, say $10, $15 and $20 million, there is a limited supply on the market. If you have the right product, you can sell it very fast.

What’s happening with prices and sales volume in new development?

The major change is in units priced between $1 million and $1.8 million. Those units are seeing a slowdown in the pace they are selling. It’s not that you can’t sell them; it just takes longer.

What are lenders requiring for new projects, and how is that different than six months or a year ago?

They require a very strong developer and a sponsorship track record, much more equity (at least 25 percent equity), and you need to be able to put the balance sheet on the line to get some type of a guarantee. None of this was required six or nine months ago.

Louis Dubin president/CEO, Athena Group

Are developers shying away from starting up new projects now?

Yes. However, viable rental projects today make a heck of a lot of sense. We have been able to buy our construction costs at a more affordable price, so we are bullish on new starts on multi-family rentals in high-growth markets. We have put off a number of projects for the foreseeable future in ’08. Our new projects won’t start until ’09. We have done well on land cost. In slow markets, it precipitously depresses the price of land. If land is a lot cheaper, then a multi-family rental will make sense again.

What is the most positive aspect of the new development market right now?

Land hasn’t adjusted, but it’s going to be cheaper. It is one of our basic food groups and has been very highly priced, but in many cases will come back down to earth.

What is most worrisome about new development?

In many cases, lenders are looking for a reason to call a default, so people currently building something have to be sure that they dot the i’s and cross the t’s. If a developer is out of whack with line items on a pro forma, and if a bank wants to be difficult, they can find you in default very easily. Very few lenders would fund cost overruns, whereas a year or two ago, it would have been much more likely.

Are you seeing new developments get in trouble?

Yes. Some have cost overruns — the developer doesn’t have the money, and the project is going to stop unless the developer finds the money.

What has happened to the first-time, novice developers?

They’re gone unless they had their deal approved last year. They’re teaming up with guys like me.

Which types of units are selling best?

The big stuff, the three-bedroom plus, and the smaller units — value priced under, say, $1,200 a square foot. There’s a shortage in that market.

What are your plans if the economy gets worse?

We have structured most of our deals to be able to weather a couple of years of not starting. In the interim, we’ll be buying other people’s distressed projects and recapitalizing them and finishing construction.

What are lenders requiring for new projects, and how is that different from six months, one year or two years ago?

They are requiring stellar sponsorship and a very good track record. You’re only able to borrow 65 percent of cost versus six to 24 months ago, when you were able to borrow 75 to 80 percent. The borrower is required to pay more in interest; in some cases, they are requiring guarantees on a portion of the debt.

Daren Hornig managing partner, SAXA

What is your outlook for residential development?

There are two sides of the coin in residential development. It’s going to slow significantly [because of] the extreme credit crunch. And 421a is going to change. From a consumer perspective, [buyers] think prices are going to drop. However, I think the opposite is going to happen, and prices are going to rise due to supply and demand constraints and the weak dollar. Without the 421a tax incentive, the effective price is going to significantly go up. The established developers [will see] more opportunities. Everyone who became a developer in the last five years is going to fall by the wayside.

What is the most attractive area of residential development?

Rentals are like dinosaurs. Unless you own the land for a long time — anywhere from five to 20 years — with the changes made by this administration, we will not see rental construction again. That is extremely dangerous for the market.

How has the climate changed for starting up a new project?

[Compared to] before August, it is literally night and day. We were able to get 90 to 95 percent financing with two phone calls. Now, we are lucky to get 50 percent.

What is the most positive aspect of the new development market?

There’s less competition, and that fares well for new development. The new condos coming to market will fall about 20 percent a year for the next five years, which will cause the prices to remain high.

Any notable deals you’ve seen recently that indicate where the market is at?

We are focusing on joint ventures where people acquired land or are in the development cycle where they thought they could get tremendous financing and are finding banks saying no. We are being approached by people for late-stage equity partnering.

What surprises you most about the new development market right now?

Everything coming up now is a ’09 project. What I do like is [that] the quality for development has gone up significantly. On the down side, if you have a project on the table in late ’07 to now, things are not going to get built. The banks are digging in their heels.

As far as sales go, what segments of new development are the most active now?

The high-end for sure. The rich are only richer over the last five years in this cycle. People are collecting apartments like they collect art. We are looking at product that is $2,000 to $6,000 a foot.

Looking outside of residential development, what sort of development is best overall?

There was a frenzy of hotel development over the last 18 months. Hotels at the high end and the low end will do fine, but the mid-level will ultimately get hit. Too many of them got built, so there is too much supply. New York is doing fine, but the second that it takes a step back, there will be less business travelers.

What are your overall plans if the economy gets worse?

We are going to buy as much as we can in the next two years and position ourselves. Classically, it is a cycle of approximately a two- to three-year downturn and seven years of boom. If [you] position well and don’t get caught in a bad position with your product, you can really capitalize.

Fred Harris senior vice president, development, AvalonBay Communities

What is your outlook for residential development?

While there are signs of general economic downturn nationally, current production levels in this region are so moderate that there is little likelihood of serious oversupply in the multi-family arena.

Are developers shying away from starting up new projects now?

While there is some talk [about how] that is the case, I do not have any direct knowledge of a multi-family project that’s been halted. The widespread awareness of the shortage of bond financing for 80/20 developments indicates that there is a not a shortage of developers who want to use it.

Any telling statistics when it comes to new development?

If you look at building permits, there seems to be a moderate slowing of the pipeline. I have not seen any sign that ongoing developments are not being completed.

Norm Kaish senior managing partner, Kaish & Taub Development Group

What is your outlook as far as residential development right now?

We are continuing to build. We are taking two new projects out of the ground in order to comply with the 421a tax abatement. We believe in residential development in New York. Having said that, we did change our plans for one condo project to a rental project, and that was primarily to make the banks feel secure. Williamsburg has a glut of condos with a number on the [books]. Many are not getting built; some have been offered as fire sales; others are being offered in pre-development. One broker sent me 23 properties that were scheduled for condo development that are not going to go forward.

Are developers shying away from starting new projects?

I have heard a number of stories that many banks are showing up at the closing without money. As a developer, there are so many variables we are juggling: the marketplace, the contractor, the raw materials, zoning, code requirements, labor rates. But in the past, the one absolute stability was the bank. You could always depend on the bank … if the project made sense. I’m not sure if any bank is dependable today. In our case, there was skittishness on a project in Gramercy Park. We had letters of intent from UBS, a multinational bank, for the land acquisition, the mezzanine loan and the construction loan for months. After signing the documents, their private banking group Dylan Reed went under, that department closed and the parent company picked up the land loans and completed the assemblage. Sixty days later, UBS closed their real estate department and announced a $3.5 billion write-off in their real estate department.

What is the most positive aspect of the new development market right now?

Two out of three calls we get are from [international] entities looking to purchase multiple apartments. The flip side is there are going to be many less people on Wall Street able to buy luxury apartments. We are in a downsizing market when it comes to employment on Wall Street. There was a time that Wall Street drove the market. You don’t see that anymore; there are lots of lawyers, accountants, artists, brokers and other professionals unrelated to the Wall Street bonuses, not to mention the foreign buyers.

Any notable examples of deals you’ve seen recently that indicate where the market is at?

In Williamsburg, the Edge [sells for] $900 a square foot, which is pretty high for that marketplace. They booked sales this weekend [in March].

What surprises you most about the new development market right now?

The fact that there are no banks. There are only a handful compared to what there was a year ago.

What is most worrisome about new development?

The price of oil and the importance it’s going to have on materials, not to mention the entire economy.

What’s happened to the first-time developers?

They are done. There is no bank that is going to lend unless he’s got very deep pockets.

Looking outside of residential development, what sort of development is best overall?

We are doing retail, even though we are in a recession. It’s normally a soft area, but we haven’t seen a waning. Hotel has been booming. I think it has been reduced over time because of inability to get lending, but it is still a good market. Market studies for the hotel industry are still strong for New York. There’s some softening in the occupancy rates, but that’s insignificant compared to profitability, which has gone from fantastic to very good.

What are your overall plans as a developer if the economy gets worse?

We [will] probably move more toward rentals. People will always need a place to live.

What are lenders requiring for new projects these days, and how is that different from six months, one year or two years ago?

They are requiring much more equity from developers. Some are not allowing mezzanine loans behind the senior. We have probably signed up about 13 new investors who are looking to move money out of the stock market and place it in real estate. Historically, it has always been less volatile, but if you are a long-term player, both are OK. If you’re on the bottom floor on real estate development, you may not make a ton of money, but you will make money. That’s not always true in the stock market.

Henry Justin principal, HJ Development

Are developers shying away from starting up projects now?

Developers are best served by completing their existing projects.

What is the most attractive area of residential development?

An as-of-right condominium conversion in a tried-and-true Manhattan neighborhood.

What is most worrisome about new
development?

One of the best-kept secrets of developers is the efficacy of their projects. They’re not likely to make their shortcomings available to their banks in terms of project overruns and/or completion.

Josh Guberman president & CEO, Core Development Group

What area of residential development is most attractive?

As a rule, new construction is the most efficient and certain way to plan a project and insure adherence to projected costs and planning. Conversions and renovations of existing structures for development always carry the X factor. Unforeseen conditions, increased construction costs, project delays and unexpected surprises are more the rule than the exception with conversions. Condos that are built properly in quality neighborhoods will continue to do well. Rentals are certainly an emerging trend in this volatile market.

What has happened to the first-time, novice developers?

They have fallen prey to the standard template for any business failures. Unrealistic expectations regarding sellout projections, poor or shoddy craftsmanship, gross underestimation of construction and development costs, uneducated risk taking in secondary markets that are flooded with like projects, and more.

As far as sales go, what segments of new development are the most active?

The rush to the market by European and Asian buyers has slowed as have the speculative investors.

Which types of units, in terms of size, are selling best?

Larger units that accommodate a family lifestyle are clearly leading the market as are smaller affordable studios, as they represent the last affordable space one can buy in New York. The high end (residences that sell for upward of $3 million) is still strong.

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