A growing number of developers with projects under way in
Manhattan, who are already reeling from declining real estate values
and high construction costs, are being confronted by lenders who are
either unwilling or unable to continue funding, according to real
estate experts.
The Lehman Brothers bankruptcy, which was filed in mid-September,
has — not surprisingly — put several construction projects in the city
on hold. But other lenders are also putting pressure on developers to
provide more equity in projects as a way to improve the financial
profile of their struggling banks, real estate attorneys said.
The actual or even the potential withholding of construction funds
is ramping up pressure on builders, who would be stuck continuing to
pay carrying costs on their sites, even if construction is halted.
Typically, after construction has begun, a lender releases funds
each month depending on the monthly draw — or the amount of work that’s
been accomplished. Now, however, many say that banks are becoming more
aggressive in looking for breaches of contract, and are requiring
developers to fund overruns that they once turned a blind eye toward.
As for Lehman’s projects, it is still unclear what Barclay’s $1.75
billion partial purchase of the company, which included Lehman’s 745
Seventh Avenue headquarters, will mean for the developments Lehman was
funding.
Barclays has not said which loans will be picked up and which will
be left hanging. Lehman was involved in an estimated 2,400 real estate
investments nationwide, but it is also unclear where all of those
projects are located and how many of them involve construction, real
estate experts said.
In New York, one of those projects is being developed by Swig Equities
at 25 Broad Street in the Financial District. A number of
subcontractors who have not been paid because of the Lehman bankruptcy
have filed liens on Swig’s project, and at least one firm, Nova
Development Corp., has filed a lawsuit in Manhattan Supreme Court.
Note: Correction appended.
The project — a 346-unit condo, which, according to the city’s
Department of Finance, was funded in part by $207 million in mortgages
written by Lehman — has seen its funding frozen, the developer said in
a statement.
In several other Lehman Brothers-financed projects in New York
City, funding has been withheld for some period, according to a
developer and other sources.
In addition to the Swig conversion, there are two condo
developments in Sutton Place being developed by Alexander Gurevich that
the investment bank financed. At one of them — an 18-story, 75-unit
condo at 313-317 East 46th Street at First Avenue — construction
activity had been on hold for several weeks as of Oct. 20, neighbors
said. Two sources said financing on the project was stalled by Lehman’s
bankruptcy. A visit revealed that the first four floors were visible
with no work progressing.
At the other development — a 24-story, 88-unit condo named the
Alexander, located a few blocks away at 250 East 49th Street at Second
Avenue — construction is continuing. Calls to Gurevich’s office were
not returned.
On the whole, the future of Lehman Brothers-backed projects is
difficult to ascertain. A real estate source with direct knowledge of a
Lehman commercial construction project in Manhattan, which he would not
identify, said Barclays had funded the most recent draw in early
October. A spokesman for Barclays said he would not comment on
individual projects, citing client confidentiality.
Not just Lehman
In a non-Lehman-backed development, a condo under way near the High
Line ran into financial straits when it incurred $30 million in cost
overruns, said David Schechtman, senior director of the turnaround and
distressed group at Eastern Consolidated.
The developer needed the money to make debt payments, Schechtman
said. Along with partners Eric Anton and Ronald Solarz, he secured $30
million from a private equity entity in September so that construction
could continue.
Schechtman said there were many development sites in Manhattan
facing financing troubles. “There are several dozen projects in peril,”
he said.
Other projects under construction could be facing the loss of
funding for several reasons. In some instances, a short-term land
acquisition loan is coming due, or a development may be over budget and
the lender, during a monthly loan balancing process, demands more
money.
Two years ago, if a development was out of balance the bank would
look at the increase in potential prices per square foot and roll the
cost overruns into a larger loan, said Gary Rosenberg, founding partner
with Rosenberg and Estis. But now, as prices in the condo market have
fallen, the banks have demanded fresh equity to make up shortfalls.
“Banks want to figure out what is happening and how to get out with
a profit,” he said. “If the existing borrower does not have the
wherewithal to get there they are looking for an alternative to work
with.”
As a result, the banks are now pushing developers to plug in the funding when a project has gone over budget.
“So the developer has to raise $10 million or the bank says, ‘I am
going to stop funding, and I will even start foreclosure,’” said
Rosenberg, who is reviewing three projects in the city where banks have
put pressure on developers.
Rigorous reviews
Banks such as Citibank, UBS and others are squeezing developers by
tightening up lending requirements for short-term loans or calling for
additional funding in over-budget projects, experts agreed.
“If the loan is out of balance [or it appears out of balance], many
banks are being very aggressive,” said Eric Zipkowitz, a real estate
partner at the law firm of Wachtel & Masyr who specializes in
construction law. He recently worked on obtaining additional equity
required by construction lenders for two commercial projects in the
city and is working on a third.
Zipkowitz said that about a year ago, when credit was easier to
obtain, banks were more flexible in allowing a developer to use its
construction contingency, which is generally between 7 to 10 percent,
to cover cost overruns if the loan slipped out of balance.
But they are much less likely to do so today and instead will
require an additional equity infusion to cover the overruns and
preserve the contingency fund, he said.
In some cases, developers have no choice but to defer funding of
their developers’ fee, which can run from 2 percent to as much as 3.5
percent, until the project closes out.
Zipkowitz said sometimes the equity infusions that banks are
requesting are without justification. Banks, he said, have begun
scouring the loan documents for technical defaults or other minor
non-conformities that were often overlooked in the past as leverage for
requiring the additional capital.
“For the developer, the key is to keep the project moving forward towards completion and lien-free,” he said.
Even if the bank is asking for more equity without justification,
the developer may have no choice but to capitulate, as the time lost in
an arbitration or litigation (during which funding would stop) could be
the death knell for a project.
“Sometimes there are valid reasons and sometimes there are not,
but for the most part, in today’s environment, it may not matter,
because it still has to be worked out quickly to keep the contractors
paid and the project moving,” Zipkowitz said.
Still, many say they don’t expect New York City development
projects to be abandoned by banks midway through construction. They say
that banks, even those that are struggling, will continue funding
unless they absolutely cannot, because if they stop they will have an
incomplete, money-losing project and the prospect of lender liability
litigation to contend with (see Q & A: Lower lending expectations.)
Leonard Boxer, a partner at Stroock & Stroock & Lavan, said
lenders will honor their obligations to finance projects, but will be
more rigorous in reviewing finances.
“The institution will follow through with the commitment and fund
it. [But] you see there is much that goes between the cup and the lip,”
he said.
Rescue plan
Although the credit market for construction loans in New York City
has been tightening all year, it all but ceased as a result of the
turmoil on Wall Street, the federal bailout and the plunging stock
market.
Meanwhile, many stalled development projects are on the market, but buyers are waiting on the sidelines for a bottom.
“No one wants to be perceived as a hero,” by jumping in and buying
now, said Patrick O’Malley, a broker and managing director at real
estate analysis firm DTZ Rockwood. (He was formerly a senior broker
with Massey Knakal Realty Services focusing on Upper Manhattan.) “You
are going to see a lot of pain, especially in Harlem and the Bronx.”
But Schechtman of Eastern Consolidated expected projects to be
rescued in one way or another. “I wholeheartedly believe that many of
the projects will be completed in one form or another, whether with new
cash to an existing developer or new cash with a new developer.”
