FEATURE ARTICLE, SEPTEMBER 2007

LENDING IN THE NORTHEAST
The highs and the lows of the lending environment in the Northeast.
Matthew McManus

McManus

It’s a good time to be a lender in the Northeast. The current lending environment is supportive of a variety of real estate plays, including ground-up construction for hotels, apartments and industrial properties, and this all at a time when investors are shying away from finite residential sales and looking toward income-producing real estate, especially as the price of land has come down over the last 6 months. 

Apartments are Back

Developers in many of the major cities in the Northeast, including Philadelphia and Boston, jumped into the condo frenzy of 2006. Now many of these developers are finding themselves with an oversupply of condos in a market that does not demand them. The result is the conversion of many of these buildings into income-producing apartments. The same stands true for buyers who purchased land for the purpose of building condos. They are now looking into other projects for the property. Over the past year, apartment buildings have presented a great opportunity for these plots of land. 

This trend in conversion to apartment buildings isn’t just a condo phenomenon either.  In New York several thousand guestrooms in existing hotels have been converted to residential use. Despite the fact that hotel economics have been strong in New York, residential economics have been even stronger. Across the Northeast, investors are seeing a higher economic return from residential conversion. 

Hotels are Hot

Sellers are no longer holding out for condo developers. Instead, land pricing has begun to come down enough so that it can be purchased cheaply enough to support hotel construction. Corporate and leisure travel have both been strong and an important factor in the U.S. economy over the past year, which has in turn resulted in an increase in lodging demand. This demand is expected to continue over the next few years, producing higher room rates and profits for hotels. In addition, many major urban markets, including New York and Boston, have experienced a resurgence of tourism, which has also helped yield stronger hotel markets. This demand, in conjunction with low-cost debt and equity capital, has increased activity in the hotel sale and development transaction market.

Ground-Up

The amount of ground-up construction so far in 2007 has been reminiscent of the amount completed in 2006. This is in part due to the cost of land coming down, which has allowed for buildings such as hotels and residential rental properties to be built in prime locations. Unlike 2006, when many projects were about converting older structures into condos, this year, many investors see a strong opportunity with ground-up construction. This is good news for developers, especially because there is a large amount of investment capital available in many major urban areas such as New York City. Because of the availability of capital, many larger transactions are happening quicker than usual. 

Industrial Property Opportunities

Yet another asset that is hot right now in the Northeast is industrial properties. In particular, the construction of warehouses and light manufacturing facilities has grown substantially as a result of a surge in business activity. The volume of industrial construction underway increased nearly 10 percent during first quarter 2007. Private company growth has been steady over the past year, and this is expected to remain true for the next several years.

Although 2007 is shaping up to be a strong year for the investment market, it has not been without its challenges. Despite the low cost of land and the surge in ground-up construction, there is still a lack of product to satisfy all of the new buyers entering the market. Investors need to consider rising interest rates, increasing energy and insurance costs, and volatile consumer confidence before making a move.

Financing

The recent residential subprime problems, along with some rating agency downgrades, have finally impacted the commercial lending/investing industry. Many lenders and investors are not even quoting new loans until the secondary markets settle down. The deals that are getting quotes are being quoted with high spreads not seen in more than 10 years.  This in turn is impacting the entire industry, making it almost impossible to purchase income producing real estate. Again, the best place to be now is adding real value to an existing asset or building a new one. While the current state of the securitization market is negatively impacting the permanent mortgage market, lenders and investors still have confidence with their sense of supply and demand and are making somewhat risky land bets that future projects will perform. So, there is a light at the end of today’s somewhat dark tunnel.

Matthew McManus is the president of BlueStone Real Estate Capital.

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