Commercial real estate lending is the bread-and-butterbusiness of community banking on the Gulf Coast. With vacancies rising, could this sector overwhelm banks with bad loans?
As the Gulf Coast economy continues to struggle, commercial real estate is starting to feel the pinch. Vacancies are rising, rents are falling and banks are starting to get tough on owners of commercial real estate.
Just ask Jason Grant, a Fort Myers business owner whose bank started foreclosure proceedings on his 5,000-square-foot commercial building despite the fact that he says he's never been late on a payment. His crime: The rain-gutter installation business he owns was down 40% in sales last year and his profit-and-loss statement didn't look as good as it used to.
“They want to foreclose. End of story,” Grant says, declining to name the bank.
The fear for bankers, of course, is that commercial real estate is about to collapse as tenants vacate space. An analysis of data from the Federal Deposit Insurance Corp. of Gulf Coast-based banks with assets of more than $200 million shows a clear trend of commercial real estate loans where borrowers are at least 90 days late (see accompanying table).
Stories of tenants abandoning commercial space or falling behind on their payments are becoming more common. Kelley Geraghty Price, an attorney with Cohen & Grigsby in Naples, says one of her landlord clients had a tenant who left one evening without warning and never reopened his store. “They left a huge balance,” she says. Another Naples client has a shopping center on U.S. 41 whose anchor tenant is behind on his lease by $60,000, putting the landlord in a bind. “He can't evict them and have empty space,” she says.
Statistics show rising vacancies in all Gulf Coast markets. In the Tampa Bay region, for example, the area's vacancy rate in office buildings jumped from 12.5% at the end of 2007 to 15.9% at the end of 2008, according to data from Cushman & Wakefield, a commercial brokerage firm.
But most observers don't think the problems in commercial real estate will get significantly worse. “My initial reaction is that we're not going to see anything near what we saw in the early '90s this time around,” Larry Richey, Cushman's senior managing director for Florida.
During the last downturn in the early 1990s, vacancy rates in the Tampa Bay area spiked to more than 20%. But that's because there was a huge oversupply of new buildings. “We don't have the same supply problem in most property sectors,” Richey says.
Except in certain pockets, developers and builders were more restrained than they were heading into the last commercial real estate downturn. “That has kept the fundamentals pretty much in place,” says Ray Sandelli, senior managing director at CB Richard Ellis commercial brokerage in Tampa. “We're not exacerbating the issue with new supply.”
For Florida community banks, commercial real estate loans haven't been nearly as troublesome as construction and development loans. For all Florida banks with assets over $200 million at the end of 2008, 2% of commercial real estate loans were a problem compared to 14% of construction and development loans, FDIC data shows.
But the concern is that commercial real estate loans will worsen as vacancies grow. So far, some banks have been harder hit than others and the percentage of bad commercial real estate loans is still in the single digits for most banks.
More than 27% of the commercial real estate loans at Florida Community Bank in Immokalee are at least 90 days past due, while none is at Florida Gulf Bank in Fort Myers, for example.
“It's a dicey time,” says Stephens Woodrough, a banking consultant in St. Petersburg who was the former head of legal affairs for the Atlanta region of the FDIC. “Capital and reserves are what's at stake,” he says.
Owner occupied buildings
Despite being headquartered in one of the hardest-hit areas of the Gulf Coast, Florida Gulf Bank is one of the few banks that avoided the ill effects of the commercial real estate market. “Almost all our commercial real estate loans are owner-occupied,” says William Valenti, president and chief executive officer of Florida Gulf.
Valenti avoided the multi-tenant office, industrial and retail buildings that are now seeing tenants departures, despite the temptation to do so during the real estate boom. “When things were blowing and going, we looked at it many times and wondered if we were missing an opportunity,” Valenti says.
Fortunately, Valenti stuck to lending to owners of buildings who will actually use them, not lease them out to others. But Valenti says some of his commercial real estate borrowers may start to fall behind on their payments if things don't improve. “The longer this thing goes on, the more good people get drawn in,” he says.
By contrast, more than 27% of Florida Community Bank in Immokalee's commercial real estate loans are “non-current,” which the regulators define as loans past due at least 90 days or in non-accrual status. As of Dec. 31, about a quarter of the bank's loans were for commercial real estate. Over half the bank's loans are in construction and development and, of those, 36% are non-current, according to FDIC data. The bank consented to a cease-and-desist order with regulators in October over its lending practices. Officials with Florida Community Bank could not be reached.
At Flagship National Bank in Bradenton, the problems in commercial real estate are concentrated in two big loans, says Stephen Jonsson, president and chief executive officer. “One was a restaurant that went out of business. The other was a mom-and-pop interior design firm,” he says.
Jonsson says banks are caught in a tough spot. While banks like Flagship want to help their customers weather the downturn, banking regulators demand they take a tougher line. “We're just stuck in the middle of it,” he says.
Jonsson says he doesn't blame regulators. “Their life isn't a lot of fun either,” he says. No one wants to be hauled into a congressional hearing to be grilled by legislators. Still, Jonsson says some relief could go a long way. “If we could have a little more leeway without crippling us...a lot of people will survive this.”
At First State Bank in Sarasota, loans for commercial land is the sore point. “The difficulties have been in the commercial land loans that did not have an income stream to make the payments,” says John “Jed” Wilkinson, president and chief executive officer at First State Bank. “Over the past couple of years, it's been more and more difficult for those folks to meet their obligations.”
Both Jonsson and Wilkinson say they've adjusted the loans of struggling commercial property owners, such as lowering the payments. “I don't want to own the property,” Jonsson says, who notes that he'd rather write the loan down and take the subsequent hit to earnings and capital. “In certain instances, where we had faith in our borrower, we entered into forbearance agreements,” Wilkinson says.
“On income-producing properties, we have guidelines that we're looking for NOI [net operating income] to cover 120% of the payment,” says Wilkinson. “In these times, where you have someone who's a proven operator and the rents have fallen, so long as there's 100% coverage, the bank can work with the borrower.”
For now, most banks appear to be working with borrowers. “I'm not seeing a spike yet in foreclosed properties,” says Cohen & Grigsby's Price. “The last thing these banks want to do is to take on a major commercial property.”
“I haven't been engaged to do foreclosure work for retail and office properties yet,” says Thomas Tippett, a real estate consultant and appraiser in Bonita Springs who runs his own firm, T.A. Tippett Inc. “I have to suspect there are going to be some.”
But Tippett says commercial real estate loans made during the boom were much more stringent than their residential counterparts and usually include a personal guarantee from the borrower. “It's going to get worse, but I don't think we'll see the same percentage of commercial foreclosures as residential.”
For the commercial real estate market to improve, most agree that job creation must return. “You don't have a 12% unemployment rate without having an adverse effect on valuations,” says Gary Tasman, executive director of Cushman alliance member Commercial Property Southwest Florida in Fort Myers.
Lee County's 12% unemployment rate is the highest on the Gulf Coast.
“You've got to get people back to work so they can buy houses,” says Wilkinson. “When do we think the market is going to stabilize? That's the $64 million question.”