Vacancies build barriers to construction loans

A sign advertises available space at The Park, an office complex in Huntersville, in January. Mecklenburg Times file photo

On June 9, Charlotte-based Bissell Cos. started construction on two office buildings in Ballantyne Corporate Park.

The company calls it the largest speculative office project in the U.S. The $100 million project will add another 550,000 square feet to the corporate park.

But the project is significant for more than its size.

In today’s construction industry, speculative construction projects are rare, thanks to a glut of vacant commercial real estate festering on the market. Unless a commercial project, like an office complex, is being built for a specific client, lenders are skittish about funding it. Vacancy rates are important to lenders when considering financing a project. That’s because property owners rely on revenue from tenants to pay back their loans.

A lending problem is plaguing developers in the Charlotte area, which is dealing with high vacancies of commercial real estate.

From the fourth quarter of 2003 to the fourth quarter of 2010, the vacancy rates for office, flex and retail space rose in Mecklenburg County, according to Karnes Research Co., a Charlotte-based real estate research and consulting company. The only type of commercial real estate that saw a decrease in its vacancy rate was warehouse.

Ned Curran, Bissell’s CEO, knows his company is a rare bird. Bissell has been able to self-finance its spec project, something not every developer can do.

“We are bucking the trend,” Curran said. “The lending community would find it challenging to lend on two office buildings that have no tenant commitments yet. We know that would be a lot to ask.”

High vacancy rates also create this twist for developers: If there is a lot of vacant office space, rents will be low and potential clients are more likely to snatch up those deals instead of building a new building.

“The reality of it is it just doesn’t pencil out,” said Tracy Dodson, director of economic development for Charlotte Center City Partners, a group aimed at promoting economic development uptown. “Why build something if the rates for the most part are going to be higher than what’s out there now for new construction?”

In the Charlotte’s central business district, also known as uptown, leasing rates are averaging $23 a square foot.

“You’re not going to deliver a new building for $23 a square foot in the CBD,” Dodson said.

Also, lenders might not be willing to approve financing for a project that calls for $20-per-square-foot rent if the market only supports $15 a square foot, said Michael Ortlip, senior vice president of the Charlotte office of Branbridge Real Estate Capital, a commercial mortgage banking firm.

Dodson and Ortlip agree that if a commercial construction project already has an anchor tenant, that could be the difference in gaining lending approval or denial. Other factors, like the density of nearby housing, ease of access to a potential site and the quantity of similar businesses, like service retailers in an area, can also affect a lender’s feelings on a project.

“It’s a perfectly clear-as-mud kind of thing,” Ortlip said. “If you cast a broad generalization, vacancy in a submarket can negatively affect lending.”

Older properties = better odds of getting loans

There are many variables that factor into a lender’s decision to grant financing for a project, including what types of properties are vacant and the vacancy history rates for a submarket, experts say.

For example, in the Westinghouse Boulevard industrial corridor, many of the vacant properties are older and “functionally obsolete,” said Anne Johnson, an industrial broker and senior vice president with CB Richard Ellis, a commercial real estate firm in Charlotte.

Johnson said that while the popular Westinghouse corridor has a higher vacancy rate than other Charlotte submarkets, it’s largely because so much industrial space is available in the area, the largest industrial corridor in the Carolinas.

In the Westinghouse corridor, many of the properties are older and in need of an upgrade, and that could open the door for developers to get lending, some say.

“You could have a 15 to 20 percent vacancy in a submarket, but if your project meets the market demand, is well-located and is not obsolescent, you can make the case (for financing),” Ortlip said.

But if a project doesn’t meet market demands or, conversely, if available properties adequately meet anticipated demands and are not obsolete, “that might be a tougher row to hoe,” he said.

In the Westinghouse corridor, for example, older buildings that are ideal for a business might be leased up simply because of the cost savings, some say. A company might choose a facility with a floor plan that is not quite large enough for their needs because of the cost savings in rent.

“They may be only 70 percent efficient, but it costs less,” Ortlip said.

It’s all about the cash flow

Pete Lash, of Charlotte-based Beacon Development, said that, in his experience, what lenders are really interested in is a project’s cash flow.

“Generally, as a rule, lenders don’t want any part of vacancies,” he said. “That’s where a lot of our problems came from. They got a little aggressive on lending against projects without the ability to repay the debt service.

“Vacancy doesn’t have cash flow. You can’t borrow against it.”

Cash flow also can affect refinancing attempts.

“If vacancy rates are high, you’re bringing in less money to pay back that loan,” said Andrew Jenkins, managing partner at Karnes.

That brings about questions of whether lenders should look at projected vacancy rates during the next 10 years or consider the vacancy rates for the previous 10 years or consider vacancy rates for the submarket the property is in, he said.

Dodson agreed, saying that’s the underlying problem with vacancies and refinancing.

“What’s the true value?” Dodson said. “Nobody quite knows what to value anything at, whether it’s commercial or residential.”

Bissell builds despite vacancy rates

In the Ballantyne area, where Bissell’s two spec buildings are going up, vacancy rates have always been high, Curran said.

For years, it was because there wasn’t much of an office space base in the area. When a 100,000-square-foot building was fully occupied and another 100,000-square-foot building was constructed, the vacancy rate would plummet to 50 percent again.

“Unless you understand the market, you would ask, ‘Why would you add product if there is that much vacancy?'” Curran said. “But we’ve always had great leasing velocity.”

In 2009 and 2010, in the face of a slow economy, Bissell leased more than 500,000 square feet of office space in Ballantyne Corporate Park. In 2011, the company has already leased a half million square feet of space, he said.

Some see a turning point

Dodson is hopeful that vacancy rates will start declining and that Charlotte is at a turning point after the real estate market slump.

Lash is also optimistic and said the strength of the banks is also just as important as the quality of the project being considered for financing.

“I think the stronger banks, in particular, are starting to look at more opportunities in considering loans that they might not have considered two years ago,” he said.

Tara Ramsey can be reached at [email protected].