Real Estate Development Law Blog : Real Estate Development Lawyer & Attorney : Summit Law Group : Seattle, WA : Land Use & Green Building

From the Boston Globe, an article by Casey Ross looks at the office vacancy issue in that city.  Rents in Boston have dropped for five consecutive quarters, and are down one third to $42.46 per square foot, according to CB Richard Ellis.  Just a little higher than the Seattle market . . . He's also got a recovery prediction from Deloitte:

A survey released by the financial advisory firm Deloitte this week found that nearly 75 percent of real estate executives believe rents and property values will continue to fall in 2010. Most predicated [sic] a full recovery in two to three years. 

This is in line with what I'm reading about Seattle/Portland.

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It's not Seattle, but from Todd Murphy's article in yesterday's Oregon Business it sounds like Portland is suffering just as much as its urban neighbor to the north.  I found two pieces of useful information in this article.  First, it attempts to predict what lending will look like once we finally hit bottom and begin to recover (in 2011 or later, says the article).  The changes are not difficult to predict, but Murphy does a nice job of sketching out how a deal might get done:

 The community banks that survive for the next commercial real estate world  . . . [will] be giving loans of maybe only 60% or 70% of the now-lowered value of the property.  For some traditional titans in commercial real estate and some new cash-rich entrants into the industry, that will work out OK. Large players in the industry and others, including private equity funds, have been amassing cash during the tumult of the last year or more.

“And they’re looking for opportunities,” says Mike Paul, former CEO of The Commerce Bank of Oregon, who now is a partner in a firm helping financial institutions dispose of their non-performing assets: foreclosed properties.

Paul suggests that the new commercial real estate world, with the traditional banks being reluctant to lend very much on any property, will leave an opening for those new entities to be part of deals. The private equity firms and others, looking to place cash in a distressed market, will provide some less-traditional financing that will make up a part of the deals. The firms will do it as more expensive lenders, or in return for equity in the properties.  The private entities might provide another 10% to 20% of the value of the property, with the owner providing the final 10% to 20%.

But for right now, Murphy and those he consults see the spiral continuing down:

 . . . as the job market remains dormant, the vacancies remain. As vacancy rates stay high, building values plummet. As building values plummet, many owners owe more on their loans than the properties are worth. And community banks with the loans on their books have lost billions of dollars in asset value.  Many in the industry say some building owners without deep pockets are finding it difficult to make their loan payments or sell their buildings. (No one would name names.)

As we saw in the Seattle Times last week, that name in Seattle is Beacon Capital Partners.

The bright side in all of this is that commercial tenants are doing very well, from lower rents, to months of free rent, to great TI contributions.  I'm even finding I'm able to negotiate self-help rights in a growing percentage of the leases I work on, which was unheard of except for the biggest tenants previously.  The ability to lease space on great terms is a big help to new and expanding businesses, and ultimately to us all, as much as it may pain the landlords in the short-term.  

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I was reading the November 16th issue of BusinessWeek and stumbled upon an article  about how a "recent" Turner Construction survey of commercial real estate executives determined that 75% of such executives - including developers, rental building owners, brokers, architects, engineers, etc. would not be deterred from building "green" by the credit crunch, and that 83% of them would be "extremely" or "very" likely to seek LEED certification for buildings they plan to build in the next three years.  The further I read it became obvious that the "article" was a shameless promotion of a Brazilian energy producer (when I looked closely at the page, I realized it was a "Special Advertising Feature"), but the Turner survey results hung with me.  Was this really the case despite the cratering of commercial real estate development?  Who had they surveyed?  How recently? And was anyone really planning to build something in the next three years? I had to check it out.

It turns out the survey was completed in September of 2008 - a world away from the reality of September 2009.  That said, I would love to know what the same executives are saying today.  The population they surveyed looks diverse in terms of what role they play in commercial real estate, but did they talk to small developers and owners as well as the big players?  Turner completed similar surveys in 2004 and 2005.  Turner Construction, please release another survey soon and give us a better sense of who's providing answers, as I think that provides a necessary context for understanding the results.  In other words, if the little guys as well as the bigger players see the long-term benefits/efficiencies of building green compelling enough to spend the money on LEED certification at a time when little money is available, I'd find that compelling - and heartening.

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On Halloween, Douglas McIntyre reported in Daily Finance on a recent action by the FDIC that takes a more “liberal view” of what constitutes a nonperforming commercial real estate asset. As reported in wsj.com, the change allows “banks to keep loans on their books as "performing" even if the value of the underlying properties have fallen below the loan amount.” As McIntyre puts it, "[the] change in how the current regulations should be interpreted appears to be a fudging of the way in which federal agencies look at bank financial statements. Loans that are "nonperforming" may be restructured, but many are likely to lose a great deal of their value in the process. The FDIC appears simply to be dealing with losses that would be incurred in the normal course of business by pushing the true accounting for them into the future."  

While this may help banks in the short term (and the FDIC, who might otherwise have to insure deposits at these banks should they fail), it seems dealing with these assets for what they truly are might get us to a market correction more quickly, get the assets into the hands of those that can re-develop them, and get that deal flow I mentioned in a previous post underway.  Do you agree?  For a lively discussion, visit the comments section of the wsj.com article.  I don't mean to infer that this would be a painless process for anyone involved, but the faster we can get a recovery in commercial real estate underway, the better for everyone.  

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The October 30 Puget Sound Business Journal touts, on its front page, the Schuster Group as another fund ready to “pounce on opportunities presented by the Puget Sound area’s growing list of troubled companies.” The first such fund to get the front page treatment was Talon Private Capital, headed up by heavyweights Bill Pollard (formerly of PREP) and James Neal (formerly of Metzler). Also as reported in the PSBJ, Urban Renaissance Group has added a new Chief Investment Officer (John Bliss, another former Metzler exec) to work with institutional investors looking to buy troubled properties in town. They are not alone. Groups like Caerus Realty Capital and the major brokerage firms are circling as well. When will they investing frenzy begin? It may take awhile.

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The USGBC announced on September 2, 2009 a change in its occupancy requirement for LEED for Existing Buildings: Operation and Maintenance. The occupancy rate required for certification has been lowered from 75% to 50%. The USGBC indicates that this change is in response to current market realities that have disqualified an unprecedented number of properties from pursuing LEED certification.

Bottom line: The requirements for green building certification are constantly changing and building owners and tenants must be aware of how they might be affected by the changes. In this case, it is possible that the lower occupancy requirement will change the building’s performance data. This, in turn, could have an impact on performance specifications in contract and lease documents.

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As discussed in Mireya Navarro's recent New York Times article, the difference between building design and construction and building performance may be substantial. Owner and tenants alike should be aware of how these differences may affect LEED certification.

On August 25, 2009, the USGBC announced its Building Performance Initiative. Under the initiative, the USGBC would begin collecting data from all buildings that have achieved LEED certification for future analysis. This program is voluntary and the USGBC maintains privacy policies, however, as noted in my blog entry on September 2 (Seattle Contemplates Building Performance Reporting!), the reality of the mandatory disclosure of a building’s performance may not be for behind.

This change is in conjunction with a USGBC announcement earlier this year that will require that all LEED certified projects--from new construction to existing buildings provide energy and water usage data for at least five years. Furthermore, the requirement would remain in effect regardless of whether the building changes ownership or lessee. Non-compliance could lead to de-certification of any project that fails to comply with this requirement.

Bottom line: What do these changes mean to owners, designer, contractors, landlords and tenants? Not only should an owner be cognizant of the possibility that a LEED certified building will under-perform, but owners must include the appropriate lease language to allow for the collection of all relevant environmental performance data.

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On Sunday, Eric Pryne, The Seattle Times business reporter, broke the story many of us knew was coming.  Seattle's commercial real estate market is long due for recalibration, and many commercial real estate fortunes will be lost.  Seattle real estate mogul, Micheal R. Mastro, and his many investors now being among them. 

In his Sunday, September 27, 2009,  front page story "Hundreds Lose Big as Real-Estate King Falls", Pryne methodically outlines how Mastro took in funds to finance his real estate deals from so-called "Friends & Family Investors", giving them promissory notes pledging interest returns in the 8, 9 and even 12% level, while conveying "I couldn't care less if you invested attitude" as the investors asked questions of him.  After several decades of success, word of mouth notoriety, and a well-cultivated disinterest in selling his investors, many flocked to Mastro whose reputation of paying his investors was legendary.  But now his pending bankruptcy puts at risk well over over $100 million owed to over 200 investors, many of who are from Seattle's Italian community.

With $587 million in debt and $249 million in assets, Mastro's debt/equity ratio is not unlike over commercial real estate moguls.  But with market crash, the probably need to recapitalize his investments in order to refinance his properties, and the shortage of equity investors, bankruptcy was all but inevitable for Mastro and many others to come.  Of that, I'm sure.

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For several years states have competed to attract the development of datacenters with tax incentives, developers have reshaped their building portfolio mix to include building them, and local communities have challenged their elected leaders to prove just how many jobs the datacenters will provide the local economy in exchange for reduced taxes.

While the debate continues, commercial interests with significant electronic information storage needs can't help but embrace the move toward data storage centers.  Numerous companies have for years flocked to central Washington to build datacenters, including Microsoft, Yahoo, Ask.com, Intuit and Sabey Corporation.   Traditional commercial developers like Sabey Corporation have been in the datacenter market for a while now, recently announcing a $100+ million datacenter project.   

With Washington's Governor Gregoire predicting that over 50% of government agency's IT data needs will be outsourced in the near future (i.e. government agencies will get out of the often costly and redundant server/information storage business), can one reasonably say that datacenters are a recession proof building typology for developers?  The answer is probably no, at least until the development and operational costs of datacenters cease to be inextricably tied to state tax incentives.  That's the experience in Washington.  Many of the datacenter projects mentioned above are now on hold, because state lawmakers could not agree on tax incentive legislation.

As those projects have been developed, the competition to keep them has also been fierce.  Take for example, Washington's own Microsoft, which well be the proverbial Canary in the mine, given it's reported consideration of moving a 470,000 square foot datacenter in Quincy, Washington to Texas for cheaper electricity and better tax incentives.  

Passive observers of the technological age can't help but wonder with Google digitizing libraries whether the community library is soon to be a thing of the past, with datacenters the reality of the future.  Bottom line: keep you eyes on datacenters as recession proof economic engines! Buildings to store information in the age of cloud computing may lease up quicker than your traditional speculative Class A office building.  If the development agreements are structured to fairly allocate risk, when and if the lessee defaults, the developer may well find themselves managing and operating a datacenter at a fraction of the original cost.

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