Developers of flagging residential condo projects in the city may
be faced with a new real estate Catch-22: the prospect of having to
provide additional equity to lenders or take out more loans if they
want to cut prices to attract buyers.
The bind is a direct
result of the weak housing market, which is forcing developers to
reduce prices at the same time banks are reeling from the credit crunch
and have become unwilling to compromise on their loans.
The developers who do
discount prices can get caught in the financial squeeze because of a
little-discussed item from their mortgage known as a “release price.”
What happens is that
early on, the lender and developer agree on a price for each condo unit
(generally about 90 percent of the sales price in the offering plan)
until most of the condos are sold.
As part of that
agreement, the developer cannot go below the release price without
consulting with the bank, because that revenue is reserved for the
lender, so it’s the first entity to be paid off.
Gerald Kray, senior
director at Marcus and Millichap, a national real estate investment
advisor, said although prices remained strong in most of Manhattan,
they were falling in borderline neighborhoods, especially in Brooklyn,
Queens and the Bronx.
“The boroughs are a totally different
story; that market has cooled down a lot, and the prices have fallen off,” Kray said.
If a developer does need to go lower than the release price, the bank may ask the
developer to bring on additional partners or to take out more loans to cover the bank’s reduced revenue.
And now, those extra loans are more
expensive because credit has dried up.
Plus, “the lender is going to require additional equity,” said Kevin Comer, senior managing director of Beck Street Capital.
Just a year ago, banks were lending at about a 75/25 loan-to-value ratio. Now, that is closer to a 60/40 ratio.
“The
well-heeled can renegotiate, [but] the weaker borrowers are going to
have problems. They are getting hit on two sides: They need equity, and
the cost of debt is going up,” said Russell Schildkraut, principal with
the Ackman-Ziff Real Estate Group.
Comer expects the
weakness to expand. “We see, every day, condo projects in emerging
markets of New York City such as Williamsburg or Red Hook … where the
developers are trying to get out of those deals in one form or another
without having to restructure loans,” he said.
“We haven’t seen it in
Manhattan itself, but I suspect over the next nine to 12 months, we
will see it as well, especially in emerging neighborhoods like the
Lower East Side and Harlem,” he added.
Sofia Kim, vice
president of research at StreetEasy, said developers have resisted
slashing prices, which is costly and can reflect poorly on the project.
“Developers don’t like to cut prices, so usually, that is the last resort,” Kim said.
Abraham
Hidary, president of brokerage and development firm Hidrock Realty,
said he would need approval from lenders if he dropped prices by more
than 15 percent in any of his deals.
“But we have never had to do that. And I can’t imagine selling below that price,
because we wouldn’t be making any money,” Hidary said.
Kray
said he expected to see smaller developers lose buildings, especially
in transitional neighborhoods such as the Rockaways or
Bedford-Stuyvesant.
“In my own opinion, it
is going to reach that point, especially with the third-tier and
second-tier developers, who don’t have the experience. They are usually
the first to go,” he said.
Developers may try to
get the bank or lenders to refinance the loan at a lower rate, but real
estate financial experts said that is unlikely.
“They can always go to
the original lender to … maybe reduce the rate, which is more
uncommon,” said Albert Marengo, chief financial officer at Gary Silver
Architects, where he also consults for other developers.
Borrowers are also seeking to extend the terms of the existing loans, in hopes that the market will improve later
this year.
“Banks
will be receptive. No bank wants to take over a property, and at the
same time, they make money,” Marengo said. “I’ve definitely seen
six-month extensions.”
Elan Padeh, president
and CEO of the Developers Group, said banks were aggravating slow sales
by pressuring developers to market units before enough construction had
been completed.
“Banks are their own
worst enemy by forcing developers to do a bad thing: open a project too
early,” Padeh said. “It is happening to me right now. It shows the
banks are panicking.”
Matthew Landau, a principal with Connecticut-based real estate investor Westport Capital Partners, said lenders are
simply trying to protect their profits.
“The
bank just has to decide what is in its best interest. That might be
foreclosure, or letting units sell cheaper, or forcing the borrower to
put in more equity,” Landau said.