Where real estate meets big money, you’ll often find Charles Landry. But the Jones Walker attorney isn’t dealing with nearly as much money as he used to.
“Fourteen months ago, I was working on about $4.5 billion in [potential new] development in the greater Baton Rouge area,” he says. “That’s down to $1 billion.”
Landry says Louisiana’s reputation as a place to do business was just starting to improve, causing national developers to take the state more seriously, when the financial crisis hit. Now those same developers are laying low.
“Of all the projects I had in Louisiana, 90% were in the greater Baton Rouge area,” he says. “Now, I don’t have a major regional retail-type development at all. I probably had five or six 14 months ago.”
And the problem isn’t limited to new development. The disappearance of the secondary financing market means existing properties, including many that are still making money, could be in danger of foreclosure.
1. I know a lot of developers are frustrated with bankers right now. What complaints are you hearing?
The developers are quick to say you’ve changed the rules on us. Bankers say they have plenty of money, but you’re making it hard for us to borrow. Before, if I wanted to borrow $10 million, you might have loaned me $8 million, 80% loan-to-value, and I have to figure out where else I can get $2 million. Based on the project and my projected cash flow, I could do that. Today, instead of 80%, it’s 65%. Now I have to find $3.5 million. Well, if I had it, I probably wouldn’t need to borrow $6.5 from you.
2. Why are the requirements to get a loan so much tougher?
Banks made a lot of bad loans. I’m not saying any of our local banks did it, but many banks did, which has tightened up the underwriting requirements for all banks. The FDIC and all the regulators are being far more careful. And that has spread to other requirements.
3. Do appraisers deserve some of the blame?
I don’t think appraisers two or three years ago were being unreasonable in their value. The market was red-hot, and property in my view was very overvalued, so these appraisals were very high and very generous, which played into the hands of the developer because you could get a high appraisal, then get an 80% loan-to-value based on that appraisal. Today, it’s 65% [loan-to-value], and the values have tanked, so in some cases the appraisals are 50% or less than just 24 months ago.
4. Where is the secondary market for loans?
That’s vaporized. It used to be banks had a pool of money dedicated to, say, commercial lending. A bank would make a loan, then as the project was developed, the borrower would go elsewhere for permanent financing. Because local banks do not do long-term financing, you’d look to insurance companies and investment funds. But there is no secondary market anywhere. So the banks may have the willingness to loan you money, but they don’t have the capital to lend you money, because the loans on their books are not being taken out by the secondary market.
5. So what’s next?
Most of us believe the first shoe dropped eight to 12 months ago in the banking community, but it’s getting ready to drop again, because a lot of the loans that were placed in the secondary market are coming up for renewal, and that’s going to be a nightmare unless things change. There isn’t the ability to find someone to refinance. The lenders are going to say, “OK, if you want me to renew the loan, give me a new appraisal.” These projects are not going to appraise, and the lender’s going to be stuck with projects that are performing, but they’re nonconforming based on underwriting requirements. The lenders won’t be able to renew the loan, and the borrowers will have nowhere to go.
6. Do you see a wave of foreclosures coming?
I do. I hope that we don’t see much of that in this market. But there’s going to be vulture funds out there that are going to foreclose on these notes to grab that property, because not only are they getting the discount, if they foreclose and own the underlying asset, they have the appreciated value. Developers are doing everything they committed to do, but the market has changed, it has affected value and how the banks look at these loans, and they’re helpless because there aren’t alternatives to refinance.
7. How bad could it get?
Unless the federal government steps in with support for these loans, I think within the next 12 to 24 months it could get very ugly. And it could get incredibly ugly if inflation occurs with the federal government printing money for all of these projects and not having the ability to pay it back. You’re going to see interest rates go up.
8. You’re worried about inflation at a time like this?
Inflation and interest rates are going to be managed by the federal government for the next two years because they know we cannot have any kind of recovery with interest rates going up. How do they do that? The Reserve gives money to banks. That doesn’t help the developers. Having the banks borrow the money at 0 or .25% doesn’t mean any of that money ends up in the hands of developers for new projects. It just means banks can afford to have the interest rates on their existing loans low.
9. You say the federal government needs to step in, but taxpayers are sick of bailouts.
You have a trillion dollars in these commercial loans out there. You think it’s bad with home loan defaults? You have one of the gold-standard developers in the country, General Growth [Properties, which owns the Mall of Louisiana], file bankruptcy, that means anybody’s vulnerable. The domino effect could be catastrophic.
10. We always talk about how Louisiana, particularly south Louisiana, is in better economic shape than the rest of the nation. But from a development perspective, your experience suggests that momentum is being blocked by outside factors.
Correct, even though our market was last in [to the recession] and we’re first out. We’re not back, but we’re coming out of it. The problem is, there aren’t the [national] developers out there to take advantage of it. Those big developers are keeping their heads down right now, and they’re not going to go explore in Louisiana for a while.
