As they deal with massive write-downs and the economic havoc of the subprime crisis, big banks are increasingly cracking down on developers for being out of compliance with the terms of their construction loans.
While larger developers have, for the most part, been able to
appease the banks or find creative funding streams, less-established developers seem to be bearing the brunt of the new financial landscape. Experts say banks are increasingly looking for reasons to call a default on some of their loans.
“If a bank is skittish about a developer, that may precipitate looking for a reason for a default so they can reinsert themselves in the deal,” said Louis Dubin, president and CEO of the Athena Group, the developer of 111 Central Park North, a new luxury condo building on the Harlem side of the park.
Dubin said he is aware of at least half a dozen projects in New York where lenders are calling in defaults because of cost overruns, delays or other issues that they fear expose them to too much risk at a time when they can least afford it.
Indeed, construction loan delinquencies recorded by commercial banks and thrifts in the New York metropolitan area rose sharply — to a record 4.1 percent in fourth-quarter 2007 from 2.5 percent in the year-prior quarter, according to Foresight Analytics, an Oakland, Calif.-based research firm.
Developers in some parts of the city have been forced to secure short-term capital and mezzanine financing to save their condo projects, according to Barry LePatner, a real estate attorney and construction expert.
Mission Capital Advisors, a Manhattan-based boutique investment bank, was retained in April to sell $28 million in mortgage loans after a lender put a condo on the Brooklyn waterfront into technical default. As of last month, the 75-unit apartment building, which is 90 percent finished, was trying to rectify the situation and find a buyer for its debt.
Mission Capital declined to name the developer and the address, citing the sensitivity of the deal, but said the developer was current on interest payments and only put into default because it missed construction completion dates and unit sales targets.
“He was doing a good job; it’s just taken too long,” said David Tobin, principal at Mission Capital.
The project is expected to be done by mid-year, with initial occupancy scheduled during the next few weeks. Twenty-nine of the building’s 75 units have deposits in escrow.
In another case, Kaish & Taub Development Group was left hanging in October 2007 after UBS announced a $3.6 billion write-down and walked away from pending construction deals. While the case was not a default on the part of the developer, the bank had agreed to finance a $123 million condo project at 160 East 22nd Street and then pulled out. The developer was forced to find interim financing to meet the deadline for the city’s 421-a tax abatement program.
“The banks are not there where you need them to be,” said Norm Kaish, senior partner at the firm.
At the end of 2007, Federal Deposit Insurance Corp.-insured banks in New York had a total of $453.1 billion in real estate loans outstanding. Construction and development loans represented $46.1 billion.
Sheila Bair, FDIC chairman, wrote in a March letter to member banks, “Banks with CRE [commercial real estate] concentrations should take steps to strengthen their overall risk-management framework and maintain strong capital and loan-loss allowances.”
She continued, “We encourage institutions to continue making commercial real estate and construction and development loans available in their communities using prudent, time-tested lending standards that rely on strong underwriting and loan administration practices.”
Despite those calls for calm and continued lending, the market is skittish.
“Lenders are nervous about how the markets will continue to perform,” said Scott Singer, executive vice president of the Singer & Bassuk Organization. “They are nervous about whether sales volume and pricing will be sustained, and are looking for any signs that it’s not. At the same time, they’re concerned about anything that would cause a project to reach the market later than it should.”
Gregg Winter, founder and principal of W Financial, a Manhattan-based bridge lender, noted, “There are instances where the lender is requiring that 50 percent of the units must be in contract before they will allow closings to occur.”
LePatner, the real estate attorney and construction expert, said banks were more than willing to fund cost overruns before the subprime crisis, because they believed they could make the money back. But now, many banks have pulled out of construction lending entirely, leaving the remaining lenders at risk.
Jamie Heiberger-Jacobsen of the law firm Heiberger & Associates said that developers are facing increased risk of default all around.
“Developers have to be extremely careful these days,” she said. “The biggest thing you’re seeing right now is when they make a call and find the loan is out of balance. If you don’t make the extra payments, you’re going to go into default.”
For their part, lenders said that defaults are not called without significant problems with a loan.
“The fact that banks are calling defaults on deals is hardly ever attributed to simple delays or a slow sales pace,” said Klaus Bernhard, general manager of HSH Nordbank’s
New York office. “These issues are usually symptomatic of larger instances, such as monetary defaults, lack of loan balancing (which means there is not enough money to complete the project), or in the case of slow sales pace, a final loan maturity.
“If a loan was in compliance, and the loan has not matured, it would be difficult to imagine a deal being defaulted solely due to a slow sales pace.”
For some, the new terrain is creating opportunities. In March, Dubin’s firm created a $400 million fund to invest in distressed properties. And the Blackstone Group launched a record $11 billion fund targeting distressed real estate.
With the commercial mortgage-backed securities market “essentially closed,” as Robert O’Brien, chief financial officer of Forest City Ratner’s parent firm Forest City Enterprises, noted last month on a quarterly earnings call, some developers and private equity groups are stepping in to fill the void.