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

 Bad news for residents and businesses in the McGuire Building in Belltown.  An article in this morning's Seattle Times details the plan to demolish this nine-year-old building and explores how the owners are (or are not) helping their lessees make the transition out of the building.  Looks like they're softening the blow for the residential tenants, but if the retail tenant's quote is accurate, there's a demolition clause in his lease that allows the landlord to push him out in 60 days. That's a provision I'd like to see.  The tenant has not yet met with the owners and is hopeful he'll be offered something.  Apparently suits and countersuits abound as well.  I am interested in how this plays out and will continue to monitor the story.

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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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Green building is booming, especially in the Pacific Northwest. Look no further than your local Starbucks. Starbuck’s goal is LEED certification for all for all new and renovated company-owned stores worldwide beginning in 2010.

Despite the growing green building trend, few commercial leases have been updated to reflect the legal issues surrounding green leasing. Although there are some green leases out there, a brief survey of owners of commercial developments in the Seattle area indicates that few landlords, even those focused on sustainable building, have “greened” their lease language.

In the construction industry too, neither the architects nor the law firms representing the developers that we contacted had updated their design and construction contracts to reflect green building issues. They seem instead to be addressing those issues on a case-by-case basis. Likewise, the standard form AIA documents are silent on sustainable building issues, and do not address those issues that must be addressed regarding the owner’s green building goals and the corresponding allocation of risks.

Sustainability building and leasing risks are real, particularly in light of rapidly increasing regulatory activity at the state and local levels. Third-party sustainable building certification, and the maintenance of that certification, in combination with new building systems and technologies may provide a recipe for potential legal exposure. It is critically important to have clear contract language for each stakeholder on green construction projects and green leases. The alternative could be exposure to unanticipated liability for every participant.

Bottom line: because of the popularity of eco-friendly building projects, increasing state and local incentives, as well as possible funding opportunities from the American Recovery and Reinvestment Act, sustainability building is extremely attractive and viable in commercial real-estate when the risks are adequately addressed. As green building and green leasing continue to become the standard, the corresponding legal issues should be addressed in a coherent and comprehensive fashion.

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Local developers Othello Partners have a great piece of real estate on top of the Othello link light rail stop, and they know it. Their design for the parcel, known as The Station at Othello Park, has received a lot of buzz of late (though not everyone is a fan.

With good density, some retail, a large park space and planned LEED Silver certification, there is a lot to like about what they’re doing. And at a time when few new developments are breaking ground (and many large holes in the city are likely to remain so for a while), Othello Partners broke ground earlier this month and plan to be pre-leasing by 2011. They - and USAA Real Estate Company, who’s financing the project – clearly believe the timing is right of this sort of development, and I have to agree. While a terrific project like Thornton Creek is struggling to sell condos despite its transit-friendly and LEED certified status, the apartments there are renting on-target. Othello Station is all apartments, and I think the two year time difference in hitting the market can only be to its benefit. Looking forward to seeing this project go vertical.

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Add the Empire State Building to the list of buildings retrofitting to go green.

According to this AP article, in a challenging tenant market, higher-profile tenants want efficient spaces, and owners of older buildings (the iconic Empire State Building is 78 years old) must update systems to attract them. The article cites a CoStar Group study of green buildings that “found that buildings with the council's certification enjoyed higher occupancy rates (90.3 percent) than their peers (84.7 percent) in the first three months of 2009,” and that such buildings “rented at an average of $38.86 per square foot in the first quarter of 2009 compared with $29.80 per square foot for their peers.”

In fact, construction giant Skanska has chosen to locate their Manhattan offices in the Empire State Building and is working on a build-out they plan to have certified LEED Platinum. My favorite quote in the article echoes what a number of people in the real estate development industry have been saying for a while: "This isn't just a 'We are doing the right thing' movement," said Marc Heisterkamp, U.S. Green Building Council's director of commercial real estate. "In the end, the numbers pencil out."

Is there a downside to retrofitting your aging building to achieve LEED certification? Every case is different, but I’d say the toughest part of that question in these times is not whether to do it, but rather where to get the financing.

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Yesterday G2B Ventures, a Seattle-based hedge fund, launched a $50 million fund that will be used to purchase distressed residential properties and convert them into more energy efficient homes for resale.

This approach has been used with success in the commercial market too - examples below. I’m hoping that the reported drop in office rents in Seattle (and the Eastside) means we'll see more of this sort of sustainability-focused, value-add investment, as its time has come. A report released last August by Deloitte and environmental consultant Charles Lockwood argues that within three years "companies that do not have green workplaces will be at a competitive disadvantage from higher operating costs, lower productivity, declining attraction and retention of skilled workers, and an increasingly negative brand image." 

Earlier this year, an article by Matt Hudgens in the National Real Estate Investor reported on the partnering of L.A.-based builder Shangri-La Industries and Thompson National Properties, who announced a $100 million fund - dubbed the TNP/SLI Green Building Fund - targeted retrofitting and redeveloping commercial and industrial buildings to add significant value.  Hudgins lists examples of similar funds: the Hines CalPERS Green Development Fund (created in 2006), with a current equity commitment of $277 million; and the $100 million Rose Smart Growth Investment Equity Fund.  He points specifically to the Rose fund's $23 million acquisition of Seattle’s Joseph Vance Building (right) and an adjacent property in 2006, followed by a $3.5 million green retrofit guided by Energy Star and LEED standards. 

As someone fully behind green retrofits - both from a financial and environmental perspective, I'm hopeful funds like G2B's in the residential market and TNP/SLI Green Building Fund and Rose Smart Growth Investment Equity Fund in the commercial market proliferate and prosper.

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