Silver lining seen in declining commercial real estate prices

By Buck Wargo (contact), In Business reporter

Fri, Sep 25, 2009 (3 a.m.)

Short-term pessimism and long-term optimism sum up the mood about Las Vegas’ commercial real estate.

Las Vegas has taken a hit in its commercial real estate market, but rising foreclosures and a steep decline in values will create opportunities that will help it recover faster than other locales, panelists told the commercial real estate industry.

None of the panelists who spoke Sept. 17 to the Southern Nevada chapter of the National Association of Industrial and Office Properties said they expect a quick recovery. They said commercial real estate is languishing, and lenders are reluctant to finance commercial projects.

A recovery will be dictated by job growth that drives demand for commercial space, but with the jobless rate exceeding 13 percent in Las Vegas, it will take several years for a rebound, the experts said.

The optimism centers on declining values in commercial real estate that have investors waiting for the right opportunity, experts said. Investors may get their chance because a Nevada State Bank executive said his bank is going to be putting a lot of distressed properties on the market in the fourth quarter.

Appraiser John Wright, vice president of National Valuation Consultants, said the decline in the Las Vegas commercial market has been incredible. Many cities haven’t seen such a large decline as Las Vegas where some properties have fallen in value by 70 percent, he said.

“When you look at market declines, places like Las Vegas — the trajectory could be more sharply upward in this market when it comes back,” Wright said. “There are going to be good deals to be had. When that happens, the growth will come back.”

Patricia Nooney, managing director of CB Richard Ellis commercial brokerage in Las Vegas, said that since the valley had “a great ride upward” in commercial real estate, it’s having “an equal decline.”

Pessimism persists because the country is still losing jobs and it may not return to where it was in 2007 and early 2008 until 2013, Nooney said.

The conventional wisdom is that office and industrial space won’t hit their peak vacancy rates until 2010, and rents won’t grow until 2011, she said. Retail has been hard hit because consumers aren’t spending, and probably won’t through 2011. Rents won’t increase until 2013, she added.

“Unfortunately, what we have is government-driven (gross domestic product). The consumer and business side is declining. The government spending is the only thing propping things up,” Nooney said.

Despite those problems, Nooney said there are people ready to come back to Las Vegas when they think there is value.

“I am positive about this industry,” Nooney said. “ I have been through ups and down in other parts of the country. It will get better faster than we (think). It’s just that we don’t know when that will happen. It is going to be floating around and suddenly it will get better. I have seen it happen like that in California, Texas and the Midwest.”

For now, those on the leasing side of brokerages are keeping busy, but they are working twice as hard for the same amount of money, she said. It’s been difficult to get tenants to move and lease terms are shorter and rental rates are down, she said.

The sales side has ground to a halt over the last year with few transactions even though there has been some interest, she said.

“There are people with cash, and they want to tour the market and see what’s there and hear your opinion, but they stand on the sidelines saying I am not quite ready yet,” Nooney said. “We are seeing activity, but it is not resulting in transactions yet ... People are shopping for value more than they ever did.”

Bob Walter, executive vice president and risk manager at Nevada State Bank, told the group to look for his bank to liquidate real estate in the fourth quarter and then start pulling back as other lenders are ready to jump in, he said.

“We are aggressively selling commercial real estate at this point and will remain through at least the end of the year or maybe the first quarter.” Walter said. “We are attacking the problem early.”

It may take until next year or possibly into 2011 before the commercial real estate is liquidated in Las Vegas, he said.

Some banks are policy driven and won’t sell commercial properties for less than 80 percent of the loan to value, Walter said. Other banks don’t have the capital to sell for a big loss, he said.

“Every bank is in a different situation,” Walter said. “We’ve got a lot of capital. We want to clean it up and move on and loan money when this town rebounds.”

Nooney said the Federal Deposit Insurance Corp. takes about three to four months to market properties once it takes over, but many properties will be sold as national packages of $250 million or more to large institutional investors that sell them off one by one.

Many experts contend Nevada has yet to see the explosion of commercial foreclosures that has already hit the housing market.

Nevada State Bank’s workout department went from one person 18 months to ago to 16 today.

Walter said lenders have to be more creative in workouts such as lowering interest rates, allowing short sales in some cases and payment in exchange for debt forgiveness.

“The commercial market has dropped off a cliff since the end of last year, and what that means to us is we can’t work deals out with a customer the way we used to,” Walter said. “Before, if they wanted an extension, they would bring in cash or additional property. A lot of them don’t have that financial support anymore. It is all tied up in real estate.”

The rising number of foreclosures and lack of sales has challenged appraisers, who are turning their profession more into an art than a science these days, Wright said.

Appraising properties has been difficult because there aren’t a lot of sales to compare them to, Wright said. He said the commercial appraisals lately have been more about delivering bad news to property owners and lenders about how much values have fallen.

“The opinion of a value is truly an opinion because we do not have the facts and data set that we had before,” Wright said.

Walter said the lack of commercial sales means appraisals are more suspect. That has resulted in lenders hiring consultants and talking to developers and other lenders to get a better feel for a property’s value and what people are willing to pay.

What’s happening with commercial is no different from what happened with residential, Wright said. Homes go into foreclosure and are sold for lower prices than what they were bought for and may bring down a neighbor’s value from $500,000 to $300,000.

“This is an unprecedented time,” Wright said. “Maybe a year ago a building was appraised at $100 million, (now) I have to explain why all the parameters point to $50 million today. It takes a lot of magic to make that happen.”

Walter said lenders are just starting to see foreclosures driving down values of nearby properties that have performing loans, maybe from 70 percent to 90 percent.

There continues to be a lot of concern among lenders about the cash generated from buildings declining because tenants are going to demand rent decreases or move to another building, Walter said.

“You don’t want any more (foreclosed properties), so you work with that customer,” Walter said. “It could be a huge problem in the future. I am sure that maybe banks are going to have to lower rates or it maybe only interest (payments). If builders have cash flow, they are going to have to work with them.”

Walter said a lot of banks have a lot of exposure with commercial properties, and he’s not optimistic that lending is going to pick up until the middle of 2010.

“We got money for the right deals that we would loan money on, but we would be conservative at this point,” Walter said. “Other banks have no money for this. It will take at least until next year or later for banks to come back.”

Walter said he doesn’t expect banks to loan money on land deals for a while because that is what got them in trouble in the first place.

“They made a mistake doing that and regulators are not going to allow them to make those mistakes again,” Walter said.

The financial status of community banks depended on where they put their money, Walter said. Many community banks were fortunate in that they were startups and didn’t have a lot of capital, and they will survive because of it.

“We saw Silver State (Bank) go down because it put a lot of money into construction and land and we saw First National (Bank) do the same thing. We saw Community (Bank) do the same thing.”

Walter said banks would be willing to lend on built-to-suit projects because that is not based on the real estate market, but business’s cash flow. He said there is no interest in speculative buildings.

“Why would anybody loan on a speculative real estate project and why would anyone build one?” Walter said. “They are not worth the cost to build it with the land free right now.”