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Narrow the Spread

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  • | 4:48 p.m. October 29, 2009
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The spread that separates buyers and sellers of commercial real estate is starting to narrow. Two recent apartment deals may be an indicator of future activity, but not a recovery.

Edward Kobel is a patient man and so are his investors. That's because they need to be.

“We think there's four years left with the recession,” says Kobel, president and chief operating officer with DeBartolo Development in Tampa. “There's really nothing spurring on the economy to create jobs, so it's going to take a little while,” he says.

Despite that grim outlook, DeBartolo is buying if the price is right.

Investors including DeBartolo recently paid $25.4 million for the $69 million Corus Bank mortgage on the Palms of Monterrey apartment complex in Fort Myers and $30 million for the Georgetown apartments off West Shore
Boulevard in Tampa that sold for $125 million at the height of the boom in 2005.

And investors say they have another reason for buying distressed real estate today. “A lot of [investors] look at it as a hedge for inflation,” Kobel says. While inflation isn't a problem now, it could in the future and hard assets such as real estate will keep pace with rising prices. “Given what's happened with the national debt, there's a high probability of inflation,” Kobel says.

“There are lots of opportunities right now,” says Kirk Eicholtz, managing member of Christian Tyler Properties in Tampa who partnered with DeBartolo on both deals.

But investors must be willing to hold onto these projects for years before they realize expected returns. “They could be five-, seven- or even 10-year projects,” Eicholtz says. “We don't expect to have one- or two-year turnarounds.”

Until recently, the commercial real estate deal flow had come to a virtual standstill on the Gulf Coast as buyers and sellers remained too far apart. In the Tampa Bay area, for example, the dollar volume of deals fell 83% to $92 million in the first half of 2009 compared with the same six months in 2008, according to Real Capital Analytics.

“I think that's really changed over the last couple of weeks,” says Kobel. Sellers, he says, “are really ready to move some product.”

Looming large is the threat of a tsunami of commercial real estate defaults that could reach into the trillions of dollars.

“The big shadow is how the entire market is going to react to this huge amount of commercial debt coming due,” says John Stone, principal and managing director with Colliers Arnold in Clearwater. “It could cause the entire ecosystem to get caught in a funk that could last for years.”

That may be why lenders and other sellers of distressed properties are hurrying to bring properties to market now before things get worse. “We've been strategically reaching out to institutional investors who are the primary sellers,” says Kobel. “They're bringing us tremendous opportunities.”

Brokers say lenders and other sellers of distressed commercial properties are coming to the conclusion that conditions may get worse before they improve. “We're getting lots of calls from lenders,” says Ann Bailey, senior vice president with CB Richard Ellis in Naples. “Prices are really going to come down significantly,” she says.

Condo conversion reversion
Some of the deals appearing now are apartment complexes that developers planned to convert to condominiums during the boom and are now being resold as apartments.

“I have six apartment complexes that are all under contract,” says Jamie May, senior director with JBM of Marcus & Millichap in Tampa.

May says there were nine apartment deals from January until June and 17 in the three months from July to September. “It's the first time in 30 months that a borrower can show a lender that rents have stabilized,” says May.

While it was widely considered more of a land deal because the apartments are blighted and empty, Bank of America got 20 offers on the Georgetown property it took back in Tampa. The deal focused attention on the region and brought back investors who had largely written off the area, says Derek Pettigrew, associate broker with Cushman & Wakefield who handled the transaction.

“It helps deal volume and this was a big one for the market because it was high-profile and it was a fair price,” he says.

The 162-acre Georgetown waterfront site is one of the few large tracts of land under single ownership near the intersection of West Shore and Gandy boulevards in Tampa. The site is entitled for a marina and 1,235 residential units.

“I see a lot of the people who bought condo conversions coming to terms with the fact that they're not going to be able to finish the conversions,” says Jim Garinger, principal and managing director of Colliers Arnold in Fort Myers.
“The rents, which continue to fall, are not going to sustain the prices they paid to convert them to condos.”

Lenders are in a tough spot because they now have failed condo conversions on their books for higher values than appraisers are marking them today. If they sell, they'll have to take big write-downs, forcing them to raise more capital reserves. But as more sales occur at lower levels, regulators will force banks to act.

According to a recent analysis by Real Capital Analytics, lenders' recovery rate on defaulted commercial mortgages in Tampa so far this year is about 45%, one of the lowest of any major metropolitan area in the country. Only Detroit has a lower recovery rate than Tampa.

Meanwhile, buyers still face great difficulty obtaining financing to acquire commercial properties, even at discounted prices. Because they lack the leverage, prices need to fall further to get expected return on equity in the high teens or lower 20% range.

“All the deals that have happened were all cash,” says May. “Now they're expecting more bang for their equity because they perceive risk.”

Until recently, buyers and sellers have been unable to agree. “I equate it to the middle-school dance, where all the girls are on one side and all the guys are on the other and the dance floor is empty,” says Pettigrew. “Now, a few brave ones are venturing on the dance floor.”

In some cases, deals may not happen until the government steps in. On the Palms of Monterrey in Fort Myers, the deal didn't close until the federal regulators seized Chicago-based Corus Bank on Sept. 11.

“I had that piece under contract as far back as 14 months ago,” says Eicholtz. “The lenders and sellers can't accept that it's 30 to 40 cents on the dollar.”

Job creation is job one
To fill apartments, investors and brokers say it comes down to job creation. For the year ending in September, the Gulf Coast region from Tampa to Naples has lost nearly 100,000 jobs.

The recent increase in apartment occupancies is coming at the expense of foreclosed homes, a shadow market that by some estimates has added 10% or more to the inventory of rental units. People who rented homes instead of professionally managed apartments “found out that when the A/C breaks, they don't have anyone to call,” says Stone.

But no one expects rising occupancies to translate into rental income growth. “You've got to see strong job growth before you're going to see anything,” says Stone.

“We don't see any rent increases for 18 to 24 months,” says Bailey. When CB Richard Ellis recently canvassed apartment managers from Sarasota to Naples, Bailey says many reported that some tenants were leaving without notice because they had lost their jobs. “We've started hearing it more and more,” Bailey says.

The outlook on that front looks better in Tampa than in Fort Myers, where May says it could take five years for job growth to return. “Tampa's already rebounding,” says May, who recently moved his own business to Tampa from Naples. “I would imagine that this time next year we'll be in good shape.”


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