There’s a saying in commercial real estate, “Retail follows rooftops,” meaning residential homes get developed and sold before retail services follow to support the new neighborhoods.
It works the same whether the economic forecast is sunny or cloudy. When the new housing bubble broke and the feeding frenzy didn’t just abate but disappeared completely, residential foreclosures started, followed by bank-owned residential properties. Speculation stated commercial real estate would follow quickly as support service buildings that went up or filled up during the boom emptied during the bust.
So where does Nevada stand in terms of commercial real estate foreclosures? Just how bad is the bubble that burst?
Basically, the answer is: We don’t know yet. No one could anticipate how deep the recession would go and no one seems overly anxious to make predictions on just how long it’s going to take to climb back out of the hole we’ve fallen into. A couple things do seem evident: One man’s loss is another man’s treasure. For those businesses surviving or thriving in this economy, there are opportunities to make fortunes once the economy improves, by buying now at substantially low prices and selling later.
Another opportunity for businesses with some cash is the chance to own their own properties.
Finally, while the crystal ball is still shaken up hard enough to produce that snow globe effect, we know this: Supply has far outstripped demand and until that turns around, commercial real estate is going to struggle with tenant occupancy, bank-owned properties, defaulted loans, zombie buildings and gray shells.
Brokers
The fastest growing segment of commercial real estate today is bank-owned properties.
For brokers, it’s the fastest growing division in their businesses. Brokerages are forming divisions to work specifically with these special properties, marketing them for the owners – banks – who really don’t want to be owners. According to Frank Gatski, CEO, Gatski Commercial Real Estate Services, their company restructured internally in order to handle accounts in receivership and future investment opportunities for their clients. Because currently, there are some amazing investment opportunities, Gatski said. With the oversupply of property comes a corresponding drop in price. The economy may have stopped its precipitous plunge, but prices are still at their lowest and there are bargains out there.
“We’ve stopped the free fall but we’re going to be bouncing along the bottom for a while,” said Rob Moore, president, Gatski Commercial Brokerage. “In that time the amount of product literally owned by banks will increase. The other side of the coin is that this sets things up for recovery. Fortunes will be made based on acquisitions made by thinking people who are now buying [buildings] for cents on the dollar from where [prices] were a few years ago.”
This benefits the buyers, but not necessarily sellers, especially when those sellers are banks that simply want the property off of their books.
“All banks are different,” said Michael Mixer, managing partner, Colliers International. “They have different thresholds and risk parameters on how heavy or light to get involved in REO [real estate owned] properties. In most cases, they don’t want to take the property back. They’re not in the real estate business and don’t want to be owning and managing properties.”
“Banks are trying to stall,” said Moore, and that’s logical. Banks want to see economic conditions improve before they make radical decisions, whether that’s foreclosure or sale at significantly reduced prices.
“For the better part of a year, brokers have been bracing for an avalanche of commercial foreclosures to hit the market,” said Mixer. In addition to problems with loan valuations and performance issues, a huge percentage were set to hit maturity in 2009 and 2010, and many were expected to go into foreclosure. Instead, Mixer says he’s recently seen a positive trend of lenders working to extend maturity dates, softening stances that could have forced borrowers into foreclosure or bankruptcy if they can’t repay. Many maturity dates with loans still performing are being extended.
This stance may be due in part to the new industry catch-phrase for building owners: blend and extend. It means renegotiating lease terms to blend the lease rate and extend the term. “Some people say it’s actually blend and pretend, because 12 months from now after the lease is renegotiated we will probably not have any change in the market conditions,” said Moore. “At that time the banks will be faced with the same problem, continuing to get as much out of the loan as they can or taking [the property] back.”
“It’s kick the can down the road a little ways into the future and hope when you deal with it again you’ll be in better economic times,” said Mixer.
Banks
Banks, which don’t want to foreclose and sell anymore than they want to foreclose and own/maintain, are taking steps. “We’re always working with owners to find solutions and have established loan modification programs,” said Bruce Hendricks, CEO, Bank of Nevada. “We also assist with various community outreach programs. Our community development director is part of the leadership team that created the State of Nevada Foreclosure Prevention Taskforce.”
When a bank does foreclose, it’s not always because the bank chose to. According to William Uffelman, president and CEO, Nevada Banker’s Association, “The problem a bank has is the FDIC looks at every loan and if they decide it’s impaired, you have to set up a special reserve for it. The more reserves you have, the less lending power the bank has, because it encumbers capital. On a percentage basis, both ends of the state are probably one and the same. It’s very tough for banks right now.”
Northern Nevada is just starting to see commercial foreclosures. “The first phase probably isn’t what you think,” said Tim Ruffin, SIOR, CCIM, managing partner, Colliers International. “It’s businesses that have gone out of business and are giving the building back to the bank and the bank has to dispose of it. We’ve seen it from homebuilders whose company closed up and they owned buildings and defaulted and other smaller businesses that were in buildings they owned and because business failed, defaulted on the mortgage and the bank took it back. But they’re just starting to hit the [Northern Nevada] market now.”
Jim DeVolld, president and CEO, First Independent Bank of Nevada, concurs. He’s not seeing as many commercial foreclosures in comparison to residential. “People are struggling, but they’re figuring out ways to make concessions or do things to help cash flow to keep the properties and make payments. Usually they have a lot of equity at stake and the owners want to maintain the property if there’s any way possible.”
Though it’s possible that what we’re seeing in Northern Nevada is a lag behind Southern Nevada as well as the lag of commercial real estate behind residential. “I’ve seen several articles tracking unemployment and commercial vacancy rates that state they’re going to march in tandem,” said DeVolld. “As unemployment increases, so will commercial real estate, office, retail, etc., as small businesses fail or decide to work from home or combine space with another company.”
But product is starting to move. Buyers, according to Harry E. Hinderliter, III, senior vice president, Nevada State Bank, range from end-users to those who want to flip the property. “Perhaps they’re commercial property owners who want to acquire and finish properties, home builders who want to buy and hold for future use. Also buyers may be some kind of fund that buys properties at substantial discounts to reflect the risk and holding period, then flips that property or sells the asset for gain.”
Grays and Zombies and Land, Oh My!
So just what’s out there? Gray shell buildings. Zombie buildings. Owner-occupied buildings going back to the bank. Raw land.
Gray shell buildings are finished on the outside and not on the inside. They lack HVAC, electricity and plumbing. Sometimes walls and ceilings aren’t finished. Which is a typical condition for a building before a lease agreement with a tenant is signed and tenant improvements are required.
Zombie buildings are finished, but in foreclosure. No one can make a decision on a lease, so the buildings sit empty until the new owner comes in and makes a deal. “The prudent tenant always asks the landlord ‘Show me the wherewithal for the transaction if I’m going to make an offer and design the lease to prove you can pay for tenant improvements I’m asking for and services to the building,’” said Ruffin. Tenants don’t want to be obligated to a lease for property they can never occupy because it’s never finished.
Just how hard it is to sell a gray shell or zombie building is a function of price, according to Hinderliter. “Depending on the type of discount the seller is willing to take, there’s a buyer out there. Sometimes the buyer wants too great a discount, so it depends on a bank’s capital situation and how flexible it is as far as trying to resolve the problem/asset situation. The more capital a bank has, it probably has greater flexibility to discount, sell and move assets. A bank with less capital will be unable to discount assets which influences how quickly those assets can be sold.”
No Crystal Ball
“No one expected 12 months ago that we’d be where we are now,” Moore says. “As quick as the local economy went up it had no choice but to go down again that quickly.”
It’s nearly impossible for anyone to guess where rent and inventory levels are going to be in another 12 months, or how quickly standing inventory will be absorbed. “I heard from an appraiser I’ve known for years that they refuse to project the future,” said Moore. “I agree, and I find this comforting because that kind of speculation is dangerous. The fact is, no one has a crystal ball.”
But bank-owned commercial properties are starting to move. First Independent Bank of Nevada had five properties on its portfolio and three scheduled to close escrow. “That’s at reasonable numbers, or what I deem reasonable, and I don’t know why, but it feels to me like some of the investment monies is coming off the sidelines,” said DeVolld. “I think it’s a good sign for turn around in Northern Nevada if we can get some interest in properties and move them.”
“Both the residential and commercial real estate markets in Las Vegas have fallen faster and harder than most other markets,” said Hendricks. “So we may not have as much continued drop as some others may have. In residential, we’re seeing some improvement with multiple offers on some properties. In commercial, it will take some time to see a real turnaround.”
From the point of view of a community bank, fixing the problem means both sides talking. “The key component to me is the ability of a community bank to sit down and talk with borrowers and work out retainer plans that work for both,” said DeVolld. “As long as both sides are reasonable and 95 percent of the time neither did anything wrong, it lets everyone work through to the best of their ability. Times will get better and we have to get to the other side right now.”
By Jennifer Baumer
