Investor’s round up your cash and get ready for a feeding frenzy!! Check out this article on the commercial side of real estate investing. Right in our own back yard!

Next bubble: Commercial real estate

Developers, owners of buildings in Wilmington trying to stay ahead of any crisis

By MAUREEN MILFORD • The News Journal •
March 14, 2010

Signs of economic stress are spreading across America’s commercial real estate market, and experts say they may foretell the approach of a second credit crisis that could rival the residential mortgage debacle. Delaware is not immune.

Buildings that have long been pillars of Wilmington’s downtown office market — the Brandywine Building, the Nemours Building and Citizens Bank Center — all have been cited for indications of poor economic health in recent months.

A former DuPont Co. building, the Brandywine Building, is only half occupied and running a roughly $700,000 annual deficit, according to Rob Buccini, a partner in Buccini/Pollin Group Inc. The company’s portfolio includes a minority interest in the Brandywine Building, and another of its entities manages the building. In December, the loan was transferred to a special mortgage servicer, which manages problem loans, and described as in danger of “imminent default.”

Buccini/Pollin Group Inc., which proclaims itself Delaware’s largest landlord, controlling 1.59 million square feet of office space in Wilmington, has had a “rough, rough time,” Buccini said.

Just one block away, on a corner of Rodney Square, the recession has eroded operations at the Citizens Bank Center, according to a report by the trust that holds the loan on the building. According to the report, the loan is in special ervicing and the Maryland owner, Bresler & Reiner, has asked for a loan modification.

Altogether, the Brandywine Building, Nemours Building and Citizens Bank Center total more than 1 million square feet of space, or more than 15 percent of the total square footage in multi-tenant buildings in Wilmington’s central business district.

“You wouldn’t believe how pessimistic I am,” said Ernest Delle Donne, a real estate developer who has ridden out more than a few wild swings of the commercial real estate market in Delaware. “Things are going to get worse before they get a lot worse.”

The view is grim for commercial real estate nationwide.

Elizabeth Warren, head of the Congressional Oversight Panel, gave a sobering assessment of what’s in store. Beginning this year, $1.4 trillion in commercial loans will come up for refinancing, a trend that will continue through 2013.

In nearly 50 percent of the loans coming due, the borrower owes more than the property is worth, raising the risk of a wave of defaults, the panel’s February report says. Loans likely to fail were made at the height of the run-up in values. A tsunami of loan failures could create $200 billion to $300 billion in possible bank losses, resulting in serious damage to communities and families, the panel reports.

Commercial property failures, the panel said, could lead to downtown decay, deteriorating storefronts and office buildings and trouble for community banks. “Because community banks play a critical role in financing the small businesses that could help the American economy create new jobs, their widespread failure could disrupt local ommunities, undermine the economic recovery and extend an already painful recession.”

In Delaware, values are 10 percent to 50 percent less than they were three years ago, according to Pete Davisson, a partner of Jackson Cross Partners in Wilmington.

That threat was further bolstered by Federal Reserve Chairman Ben Bernanke when he told Congress last month that commercial real estate “remains the greatest credit issue we have.”

Though the oversight panel said it’s difficult to predict who will be most affected, Wilmington could find itself on the critical list. In a January property market assessment, Moody’s Investors Service diagnosed the health of Wilmington’s central office district as the weakest in the region in terms of oversupply — worse off than Washington, Baltimore, Philadelphia and New York.

“Looking out over the next year, we still expect a supply-demand imbalance as well as high vacancy rates for at least the next year in Wilmington,” said Keith Banhazl, vice president of Moody’s Investors Service. “When you have a high percentage of specially serviced loans in a small market, that’s probably a good indicator that the market is distressed.”

Donald Resnick, president of Acorn Development Corp., which is the property manager for Citizens Bank Center at 919 N. Market, said many commercial real estate companies are facing a credit crunch.

“Everybody who has debt on commercial real estate is trying to restructure. It’s happening all over the country,” Resnick said.

Daniel Reeder, executive vice president of CB Richard Ellis Inc. in Wilmington, said almost every large commercial real estate owner regionally or nationally has some trouble spots.

 

“Either they paid too much or they refinanced and leveraged up based on a value that was at the peak. Now, they’re trying to adjust the loans to bring them in compliance with today’s marketplace,” Reeder said.

The once red-hot market for sales of office buildings went into deep freeze.

“The game has changed,” Reeder said. “Most lenders don’t want to talk to investors.”

A seven-story office building called 1300 Market Street in Wilmington that was put up for auction in the fall failed to get to a suitable bid, said Jennifer Banning, who handles corporate marketing for Emory Hill in New Castle, which represents the owners. Bob Hill, one of the owners of the building, called the current commercial real estate
environment “very scary.”

Vacancy rates are running at record levels and, in 2009, the office market failed to absorb any excess inventory, ccording to CB Richard Ellis.

Wilmington Trust Corp. reports that 13 percent, or about $69 million in nonperforming loans, are related to commercial real estate, such as office space, retail property or hotels. The company doesn’t disclose details about the properties, according to Bill Benintende, spokesman for the bank.

In a recent filing with the U.S. Securities and Exchange Commission, Wilmington Trust said it experienced increased losses in its commercial loan portfolio in 2009 and further deterioration could have an adverse impact on the company’s financial condition.

WSFS Bank said it has $521 million in commercial real estate mortgages or mortgages on offices, retail and hotels. Slightly more than $2 million of those loans are nonperforming as of the end of 2009. The bank, whose average ommercial real estate mortgage loan is approximately $1 million, doesn’t disclose specifics of those loans.

“We’re clearly watching this segment and clearly see the stress that the prolonged economic recession has had on a number of these projects,” said Rodger Levenson, executive vice president of commercial banking. “It’s clearly one of the top priorities from a risk-management standpoint and it will be highly dependent on what happens with the economy.”

William Goetzmann, professor of finance at the Yale School of Management and co-author of “Securitization in the 1920s,” said Wilmington should prepare itself for a rocky few years. Wilmington is likely to see some change in building ownership, he said.

“I think this is the beginning and not the crescendo of the issues in commercial real estate for most cities in the United States,” Goetzmann said. “Anybody involved in commercial real estate is aware of the crisis.”

Greg Pettinaro, chief executive of Pettinaro Enterprises in Newport and a major developer in Delaware, who has been in the business for more than 20 years, was also pessimistic.

“This is the worst I’ve ever seen it.”

‘Disappointing’ situation

In recent months, signs of possible financial weakness have been reported at two properties included in the portfolio of Buccini/ Pollin. Besides Rob and his brother, Chris, Buccini/ Pollin has three other partners, H. Wesley Schwandt, a childhood friend of Rob’s, David B. Pollin and Greg Miller, Rob Buccini said.

The 18-story Brandywine Building — on the city’s main thoroughfare from Interstate 95 to the downtown’s Rodney Square — was long recognizable for its DuPont sign on the roof. The D-shaped building, constructed in 1972 on a
triangular plot for DuPont’s exclusive use, was the first to be renovated by Buccini/Pollin for multi-tenant offices after it was bought from the chemical giant in 1999.

In January, Wilmington’s Brandywine Building showed up in several reports put out by data and research firms that track the health of commercial real estate.

At the end of December, the $46.4 million loan on the Brandywine Building was placed with a special mortgage servicer because of “imminent default,” according to Fitch Ratings, a global rating agency. The loan also covers the nearby City Center Parking Garage on 11th Street.

The loan was flagged because it is part of commercial mortgage-backed security, in which many mortgages are pooled, rated and sold to investors. A master servicer manages the pooled mortgages. Individual loans in a commercial mortgage-backed security are transferred to a special servicer when there is any danger of default, experts said.

Buccini said the loan on the Brandywine Building and nearby garage is not in danger of default. He said the Fitch rating was triggered by a request to use money in a construction reserve account to renovate the building’s lobby. 

Buccini said Buccini/Pollin is a minority partner in the building, with about a 10 percent stake. The other partner, Wafra Investment Advisory Group Inc., is owned by an agency controlled by the state of Kuwait. Wafra declined to comment on the ownership split, other than to say it was the majority partner.

The loan is current and will continue to be current, Buccini said. The nearly $700,000 deficit will continue to be covered, he said.

“It’s manageable, based on us and our partner’s financial positions,” Buccini said.

Yvonne Compitello, director of asset management at Wafra, said the building is an important asset to Wafra and is not in default. But she said she couldn’t make projections about whether Wafra would continue to fund the deficit.

“I can’t make a commitment with respect to that,” Compitello said. “I can only comment on today. I can’t make future projections.”

The 38-year-old Brandywine Building has been losing major tenants. DuPont, which at one point occupied more than half of the building, moved out in 2008. The law firm Young, Conaway, Stargatt & Taylor announced last year it would move in 2012 to the former New Castle County Courthouse on Rodney Square, which is owned by Pettinaro. Buccini said half the building is occupied.

Describing the building’s low occupancy as “disappointing,” Buccini said the company’s goal now is to rent the building and get it back to health.

The loan on the nearby Citizens Bank Center was also sent to special servicing in December, according to a trustee’s report, which was confirmed by Resnick. Bresler & Reiner of Rockville, Md., the owner, didn’t return phone calls or e-mail messages. A trustee buys mortgage loans by selling bonds, usually called certificates, and puts out a monthly distribution statement that includes details about the mortgage loan.

Resnick said the building is “well occupied” but did not give a percentage number. The issues with the building are not about occupancy, but are based on the ratio of the loan to the value of the building, he said.

“These buildings were bought under one set of assumptions — everybody was fat and happy without the expectations of devaluation,” Resnick said.

The 18-story office building, once known as Farmers Bank Building, was constructed in 1965. In 1990, Mutual Benefit Life Insurance Co. was forced to take possession of the building in a foreclosure.

The ‘watch list’

Although securitization gives borrowers access to capital other than the neighborhood bank, it trades the borrower’s relationship with the lender from one of a community tie with a local banker to an anonymous transaction.

Trepp LLC, one of the companies that monitors those securitized loans, reported the loan on the Nemours Building, another Buccini property, had been put on a watch list by the servicer because the building’s income in relation to its debt hit an industry benchmark.

On Thursday, Midland Loan Services Inc., the company that services the loan, confirmed that the Nemours Building was removed from the watch list.

The “watch list” is made up of loans that have triggered review guidelines established by the Commercial Mortgage Securities Association.

 

Moody’s Investors Service “reviews the watch list to assess which loans have material issues that could impact performance.”

“Not all loans on the watch list are delinquent or have significant issues,” Moody’s reports.

The Nemours Building was another DuPont building. The 14-story building, built in stages from 1935 to 1942, was gutted by Buccini/Pollin and converted to office space and 85 corporate apartments. It also has the 250-seat Theater N.

Buccini disputed the “watch list” designation for Nemours, saying the building is financially strong by any metric.

It’s true the Nemours loan was in special servicing from late 2008 until August 2009, said Barbara Neuse, chief financial officer of Buccini/Pollin. But that was because Buccini/Pollin requested a one-time adjustment of the date on which cash is collected by the servicer, she said.

According to Fitch, commercial mortgage-backed securities loans are transferring to special servicing in larger numbers. In January, 248 loans totaling $4.27 billion moved into special servicing, more than four times the balance that transferred in the same month in 2009, Fitch reports.

Boom and bust

Wilmington has had its ups and downs in commercial real estate in the past 30 years, including a boom in the 1980s and a bust in the 1990s. With the new century, cheap money for office buildings became plentiful and buyers went on a binge.

“There was so much liquidity, anybody with a plaid jacket could call himself a real estate developer,” Delle Donne said.

Prices on commercial real estate skyrocketed, experts said. Delle Donne said he bid on every major project in the last decade but ended up fourth or fifth on the list of bidders.

“The prices did not make sense,” he said.

The flush days of easy money came to a screeching halt in 2007 with the residential mortgage crisis. Credit dried up.The ensuing “Great Recession” resulted in the worst economic downturn since the 1930s, with house prices declining, job numbers plummeting, company bankruptcies skyrocketing and federal bailouts.

Wilmington’s economy had its own issues, with the sale of the home-grown MBNA to Bank of America in 2006 and streamlining by DuPont. With the contraction, the need for office space began to shrink. In 2009, the office vacancy rate in greater Wilmington hovered around 20 percent, the highest level in 10 years, according to CB Richard Ellis.

Some landlords have been forced to drop rents, real estate experts said. As cash flow declines from increased vacancies and lower rents, the investment value of the buildings plummets, said Davisson of Jackson Cross Partners.

According to the Congressional Oversight Panel, many existing commercial loans contain time bombs because they will start coming due in the next few years.

In 2010, approximately $475 billion of commercial real estate loans nationwide are expected to mature, Fitch reports. The loans will be competing for scarce sources of money. The commercial mortgage-backed securities market, which keeps money in the system, is wounded. The investment market for large buildings has dried up, Goetzmann said.

“Investors are sitting on the sidelines waiting to see the bloodletting,” Goetzmann said.

Fitch anticipates delinquencies on loans in commercial mortgage-backed securities will reach 6 percent by the first quarter of this year and could reach 12 percent by 2012.

Delle Donne and Pettinaro said they were careful not to over-leverage. Delle Donne said he owned many of his assets for decades, which allows him to be flexible with tenants. Pettinaro said if his company doesn’t have the cash, it doesn’t undertake a project.

While the condition of the office market during the recession has been “disheartening,” Buccini said, he believes the real estate industry has hit bottom.

“We feel the worst is behind us,” Buccini said. With the exception of the Brandywine Building, Buccini said, the company’s real estate investments are profitable. Office leasing activity has picked up, he said. He sees credit beginning to loosen up.

Still, the oversight panel said there is a “commercial real estate crisis on the horizon. … ” It is calling for federal intervention to contain a possible wave of loan failures.

“The coming trouble in commercial real estate could pose painful problems for communities, small businesses and American families already struggling to make ends meet in today’s exceptionally difficult economy,” the panel said.

Contact Maureen Milford at 324-2881 or  mmilford@delawareonline.com.