Lenders keep close eye on real estate market

Imagine sitting in your car at the top of Flagstaff Road in Boulder, getting ready to let gravity pull your vehicle downhill. But as you ease off the brakes, something unexpected happens — the car goes nowhere. It just hangs and waits.

That’s about the right analogy for the Boulder Valley commercial real estate market. After two years of high vacancy rates and a sluggish economy, some real estate experts are waiting for the market’s vehicle to go tumbling to a bottom of foreclosures and fire sales.

But it hasn’t happened, yet — the emergency brake is still on.

For local building owners, their emergency brake has been cash reserves. The money has come from savings built up during the good real estate years, refinancing with low mortgage rates, maintaining diverse property portfolios and retaining some optimism that better days are on the horizon.

“When I started in this business, I figured that I’d have an average vacancy rate of 10 percent,” Boulder building owner Andy Cookler said. But during the local real estate boom years of the 1990s, Cookler said his vacancy rates remained much lower.

“Now that the market has turned and I’m around that 10 percent vacancy rate, I’m trying not to freak out,” Cookler said. “I’ve been conservative with my finances, and I have the cash reserves.” Like many other local commercial building owners, Cookler said he also slightly lowered his rental rates to keep tenants in his buildings.

Competitive market

High vacancy rates in the Boulder Valley (peaking around 26 percent for office space last year) have kept the area’s real estate market fairly competitive. While there have been no fire sales yet, rental and sales prices have inched downward or remained stable, in what had been a booming and growing market.

Cookler is optimistic, however, that the market will improve slowly during the next few years. Indeed, with new construction slowing to a crawl, the area’s worst vacancy rates in the office market hav Trammell Crow, a national real estate service company with offices in Denver.

Still, a 23 percent vacancy rate in the office market is an uncomfortably high number for local building owners and unless the economic recovery begins to produce more office related jobs, the vacancy rates may remain persistently high.

Even though Cookler is beating the market average with only 10 percent vacancy, those numbers are still a concern, he said. “If I see two more years of my own10 percent vacancy rates, then yes, that will worry me,” Cookler said.

Beyond the building owners, banks and mortgage lenders also are keeping a close eye on the real estate market. If the properties they loaned money on aren’t making money, the lenders can expect rising delinquencies, eventually leading to some foreclosures.

But the high vacancy rates have yet to rattle the market in this respect, said Jeff Lemon, Bank One’s market manager for Boulder and Northern Colorado.

“It’s shocking that with these high vacancy rates, we just haven’t seen any increase in (loan payment) delinquencies or foreclosures,” Lemon said.

The Boulder County Trustee’s office records do not make a distinction between commercial and residential foreclosures, but a run through the raw data shows there were only about a half dozen commercial foreclosures last year. Three have been filed so far this year.

At this point, Lemon said mortgage lenders and banks like Bank One are just trying to size up the situation.

“The only thing we’ve been doing recently is scrutinizing our customer’s cash reserves to see if they can hold on during another five to six months of high vacancy,” Lemon said. And in most situations, he said the answer has been yes.

“A lot of our clients have additional sources of cash flow,” Lemon said. “Many of them have a diverse portfolio with some retail involved, and so far retail has held strong.” Vacancy rates in the local retail real estate market have remained low at 5.7 percent, according to Trammel Crow.

Commercial refinances

Low mortgage rates have also helped many commercial building owners save money through refinancing, Lemon said. When mortgage rates hit 45-year lows during the summer of 2003, the commercial refinances were as strong as the residential.

“I don’t think I could name a client who hasn’t refinanced their loan during the past few years” Lemon said. “Some of them had been paying 9.5 percent interest, so (with refinancing) they’re saving quite a bit.” Current commercial mortgage rates are running between 4 and 6.5 percent, based on the length of the loan and how dependable the borrower is in the eye of the banks.

Even though cash reserves are keeping the local real estate market steady for now, many are aware that this emergency brake soon may loosen its grip if the overall market does not improve during 2004.

If delinquencies on loan payments do begin to rise, expect many banks and mortgage lenders to respond with required appraisals of the owner’s building. As a part of many loan contracts, the new appraisals (usually only enforced after a loan delinquency) help banks understand how they stand financially if the building were to foreclose, Lemon said.

Chuck Kurfehs, an appraiser and owner of First Commercial Appraisal Company in Lyons, said the appraisal business tends to be fairly quiet during level times in the real estate market. It’s when the market turns sharply up or down that Kurfehs starts to see more requests for appraisals.

“Values in many cases are lower, but you can’t really make generalizations in this business,” Kurfehs said. “Each property is so unique & it all depends on the location, use of property, length of the leases and the strength of the tenants.”

Kurfehs said he has seen a decline in construction loan appraisal requests from banks and lenders, but if the local high vacancy rates continue, he thinks more lender requests for portfolio or foreclosure valuations may occur.

If requests for commercial appraisals do increase, here are some of the things Kurfehs said he considers when looking through a commercial building:

” Highest and best use of the building: Is the property being used to its full potential? A strong owner-occupied building is usually highest value in this respect, Kurfehs said. In most cases, owner occupants tend to be more interested in the amenities of a building and pride of ownership, rather than income.

” Size of the building: Larger spaces and buildings tend to falter in a down market, Kurfehs said. “If you have 30,000 square feet of office or industrial space that needs to be leased that creates significant valuation issues,” he said. In some cases, building owners have started to split up their large office buildings into smaller condominium offices for sale.

” Lease rates and lease terms: How long are tenants projected to stay in the building, and what will the lease rates be when a renewal of the contract arrives? If the current lease rates are above market, that may be a good thing for income now, but come the renewal period, a building owner may project that he has to lower rates to remain competitive. If he isn’t planning to lower rates, that also could be a bad sign if the end result leads to increased vacancy or needed high-cost tenant improvements.

” Condition of the building: Age, quality of construction and upkeep of a building are some of the obvious important factors to a building’s value, Kurfehs said. He looks at necessary tenant improvements that should be made and checks to see if the building has kept up with changing market demands. Adequate parking for the building is also a big issue, he said.

” Location, location, location: While location is more important for retail and residential real estate, it’s still significant for office space, Kurfehs said. With the majestic Rocky Mountains sitting just to the west, views of the scenery are important to the value of a local building, Kurfehs said.

Once a bank or building owner obtains an appraisal, it can do a lot to steer possible negotiations about the loan payments. If the newly appraised value of the property turns out to be lower than the remaining principal loan balance, then it is often the best decision for the owner to let the bank foreclose. There’s little sense in paying on a loan that has a higher balance than the value of the building.

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