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.”