Brokers to the Banks

Brokers to the Banks

commercial real estate by Jean Gruss | Editor/Lee-Collier

Defaulted commercial real estate loans at banks in Florida could spell opportunity for brokers. One firm in Fort Myers recently set up a separate division to manage those.

Are bank loans secured by commercial real estate going to sour?

That's the question commercial real estate brokers are asking as they explore new opportunities. Some of them are betting matters will get worse for banks before they improve and are counting on that business to bolster slower sales and leasing activity.

One company, LandQwest Commercial in Fort Myers and Tampa, recently started an "asset recovery" division that aims to help lenders manage distressed loans to developers and commercial builders, for example. They're counting on the fact that banks don't have the staff to deal with managing a large quantity of foreclosed commercial real estate.

Commercial real estate lending is the way most Florida community banks make money. An economic downturn, rising vacancy rates and falling rents combined with high prices investors paid for land and buildings in recent years could swamp lenders with bad commercial real estate loans.

An analysis of the most recent data from the Federal Deposit Insurance Corp. shows Florida banks reported the percentage of bad real estate loans nearly quadrupled last year. Some areas of commercial lending are suffering even more. For example, construction and development loans at Florida banks that are 90 days or more past due surged from 0.65% of total loans as of Dec. 31, 2006, to 4.51% on Dec. 31, 2007.

Regulators are scrutinizing banks closely for their exposure to commercial real estate. In a recent letter to all banks, the FDIC reminded financial institutions they should be careful about commercial real estate loans.

"Banks with commercial real estate concentrations should take steps to strengthen their overall risk-management framework and maintain strong capital and loan loss allowances," warned FDIC Chairman Sheila Bair in a statement March 17.

Most brokers concede that the level of problem loans will depend on whether any recession is light or severe. Bank business will depend on the outcome of that question.

Stupid money

Stephen Cunningham, managing director at LandQwest, blames "stupid money" from investors who gambled in the boom years that commercial real estate prices and rents would continue to surge. Banks that loaned money to these investors are likely going to suffer losses and they'll have to foreclose or sell the loan at a discount.

Cunningham should know. As an appraiser, he performed valuation work for the Resolution Trust Corp. during the savings-and-loan crisis of the 1980s.

But the depth of the current problem is debatable. So far, LandQwest has not landed a bank client for its commercial real estate asset recovery division, though it only recently launched the service. But Cunningham says it's just a matter of time before banks start to realize they have problems. "They probably have more bad assets than people realize."

Brokers in other areas of the Gulf Coast are reporting the same trend. "Six months ago [banks] didn't think they had a problem," says Ian Black of Ian Black Real Estate in Sarasota. "The banks are coming to terms."

Banks that recognize problems ahead of time sometimes prefer to sell the loans at a discount to investors rather than foreclosing on properties and saddling their balance sheet with real estate. Rokki Rogan, a principal at LandQwest, is also the chief executive officer of Ohio-based Landmark America, a firm that buys distressed loans from financial institutions. In addition, LandQwest also represents two private-equity funds that are scouting for deals.

"I'm fielding phone calls from all over the country from people who are buying the loans," says Black. "They're calling us to find out what the situation is."

"We're talking to banks like everybody else is," says Larry Richey, senior managing director of Cushman & Wakefield of Florida in Tampa. But Richey says he doesn't expect the amount of bad commercial real estate loans to flood the market.

Unlike past cycles in the Tampa Bay area, there hasn't been massive overbuilding and deep-pocketed institutional investors such as pension funds that have the capacity to weather a downturn own much of the commercial real estate today.

"When you get over into improved commercial property, there's very little activity with the banks on that side," says Patrick Duffy, president of brokerage services with Colliers Arnold. "The stuff that banks are most worried about are some of the new developments in process."

Duffy says he recently met with executives of the third-largest bank in Florida who assured him that commercial real estate loans are not a big problem now. The numbers bear that out: Just 0.8% of commercial real estate loans at Florida banks were 90 days or more past due as of Dec. 31, according to the FDIC. Although that's up from 0.3% at the end of Dec. 31, it's not significant enough to indicate a crisis.

"That's part of the problem when statistics get thrown around," Duffy says.

Lee most at risk

Although commercial development hasn't meaningfully outstripped demand in the Tampa Bay area, that isn't the case further south. "Fort Myers is probably more at risk than the Tampa Bay region because its economy is not as diverse," says Duffy.

The tripling of taxes on new construction in Lee County last year spurred developers to start building nearly 2 million square feet of commercial space to beat the deadline and a significant portion of that space is speculative.

"The end of the cycle is more at risk because [developers'] cost basis is higher," Duffy says. For example, if a developer was counting on getting $23 a square foot for space that he can only now lease for $20, that could wipe out any equity he has in the project.

Unlike the Tampa Bay region, commercial real estate ownership and development in Southwest Florida remains in the hands of private developers rather than better-financed institutional investors, says Richey. "The Southwest Florida market, because it was so driven by real estate overall, is probably feeling the impact of this downturn more than the rest of the state," he says.

In the Tampa and Sarasota areas, vacant land is where the most significant loan problems are. "That's what most people probably overpaid for and it's what banks overfinanced," Black says.

But in the Fort Myers area, anything related to the housing crash is stumbling. For example, more than half the industrial space there was leased to housing-related trades, from tile makers to carpenters and carpet layers. Space that was leasing for $11 a square foot is now $6. "A lot of tradesmen have left the area," Cunningham says.

On the retail side, developers in Lee County rushed to build shopping centers to beat the construction-tax increase just as the housing economy was spurring a slowdown in consumer spending. One indicator of retail sales showed a 10% decline in taxable sales in December versus the same month a year ago.

Rather than foreclose on the real estate, some banks may prefer to sell the loans to investors. The courts are clogged with foreclosure cases and the slow process adds cost. What's more, banks don't want depressed real estate assets on their books. "Your first loss is your best loss," Black says.

But it's likely these investors will only settle for deep discounts to buy these loans. The investment funds LandQwest represents demand 20% annual rate of return on real estate assets over a typical five-year holding period, Rogan says.

"I get a lot of calls from investors who are waiting for banks to understand the value of their assets," says Black. "I just had three calls in the last 24 hours from colleagues in Northern Ireland."

So far, most investors are playing a waiting game. They may be holding off to see if things get worse. If they do, future returns could be even better.

REVIEW SUMMARY

Industry. Commercial real estate

Trend. Brokers are angling to manage commercial real estate for banks.

Key. Watch to see whether banks' problem loans get worse.