The Outlook on Local Real Estate

Optimism and confidence are up but a few concerns linger

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Anytime someone buys a building it helps the economy, reflects Blake George, principal at commercial real estate firm Lee & Associates. “They have to buy paint, furniture, paper, pens … If they hold up the transaction, it slows the recovery.”

That’s one way to look at the real estate market, and Kim Machotka, president of BankMarketplace.com, goes further. “Banks and credit unions lend money to consumers and businesses. Consumers buy goods and services with the money they borrow and businesses buy equipment, expand, make acquisitions and create jobs,” she says.

“Banks and credit unions need capital in order to lend money and when their capital is tied up in bank-owned property, they’re not able to lend as much money to consumers and businesses,” she continues. “With more and faster sales of these properties, financial institutions can lend more money and thereby help the economy recover faster.”

Machotka’s business helps speed those very sales, but more on that later. The point is, commerce does help the economy, but as we all know, real estate suffered a dramatic slowdown in recent years. Things are easing a bit, local experts say.

Bright Spots

“We’re seeing three main demand drivers in commercial real estate, especially in Dane County,” notes Todd Cegelski a commercial banker at Johnson Bank. “Health care-related expansion, multifamily apartment construction —vacancy is very low—and university-related projects are still moving along at the UW and Madison College.”

Vern Jesse, a shareholder at law firm Murphy Desmond S.C., cites an improved lending landscape. “There’s a perception—and it’s a fact—that banks are now lending money. The perception in the recent past, right or wrong, was that they weren’t.”

Clinton Krell, P.E., a sales representative at Spancrete, innovator of precast building solutions, observes the same. “Financing is becoming more available, enabling projects that were on hold to move forward.”

Cresa, which represents tenants, is also seeing projects proceed as the economy shows signs of improvement. “Decision makers have been more proactive with executing their expansion plans,” says Tim Rikkers, managing principal.

And many bad loans and stressed property situations have been resolved, in both residential and commercial real estate, Jesse adds. “There’s still a lot more work to do, but we have a lot behind us.”

It remains a buyer’s market. “Interest rates are favorable and prices are good, and anybody in a strong financial position is taking the opportunity to purchase,” says Shelly Sprinkman, with Restaino & Associates’ Sprinkman Real Estate Team. “And we’ve had an increasing number of relocating
buyers coming into the market in the last few years.”

First Business Bank is seeing more activity, albeit limited, in commercial real estate loans. It recently completed two loans of over $15 million for high-profile projects in Madison.

“There’s competition for good loans,” says Brian Hagen, the bank’s vice president of commercial real estate. “Banks that maintained their credit quality and capital are in a great position to lend to quality projects. There are a lot of banks with good liquidity looking to lend,”

He’s also seeing some activity pick up in the secondary markets, mostly insurance companies with stabilized apartment projects. “That market had died a few years ago. It takes business away from us, but it’s a good harbinger.”

Leasing activity remains strong as well. “For people who don’t qualify to buy—they may have lower credit quality or no down payment—there are some great deals,” says George. “There’s still a lot of vacancy in office space.”

The activity is across the board, reports Mike Herl, partner and vice president of broker services at Inland Companies. “There are huge opportunities to represent tenants with the tremendous vacancy rates. And people, including cash buyers, are looking for troubled properties.”

Buyers are becoming more comfortable with their personal financial situations with respect to the economy, observes Debby Dines, broker/owner at Dines Inc., which focuses exclusively on urban, downtown real estate. “There’s a lot of growth in that market,” she says.

“We saw substantial sales increases in the downtown condominium market in 2011,” she continues. “Unit sales were up 22 percent and dollar sales were up 19 percent from the prior year.”  

The most important driver of improvements in commercial real estate is increased buyer confidence, notes Eric Schwartz, president of Sara Investment Real Estate. “Over the last few years, I’ve had a lot of meetings with people where they describe what they want to do ‘when the economy recovers.’ In my meetings now, instead of talking about that, people are talking about what they want to do tomorrow—expand, build, invest. Maybe they’re just tired of waiting, but either way, this confidence is extremely important.”

Storm clouds

There are still some factors holding back increased market activity. “Lending criteria are still very tight, as banks try to get a handle on their portfolios and determine what segments of the commercial market they’re comfortable lending to,” says George.

“While the lending gates have reopened, the money isn’t flowing,” agrees Matt Apter, managing principal at Cresa. “Along with increased underwriting requirements, banks aren’t providing loans for speculative development. Lenders have higher pre-leasing requirements for new developments and require significantly more equity in every project than in previous years.”

Machotka cites equity requirements, too. “You have to have huge down payments now to get credit—like 25 percent for a home—where five or 10 years ago you didn’t need any money down.”

And although consumer confidence has increased, there’s still fear in the residential markets, especially outside Dane County. “We work with several homebuilders in the area that feel there’s got to be pent up demand, but consumers are concerned about their jobs and think they can’t get loans,” Hagen says. “People are looking at open houses, kicking the tires, but hesitating to write offers. There’s an uptick in activity in the last few months, but it’s too early to say if it translates to sales.”

When people do write offers, they’re generally contingent on the sale of their properties. “Some clients still have apprehension as to what the future holds,” explains Sprinkman. “In years past, they’d write offers knowing they could sell their old homes.”

There’s hesitation in the commercial world as well. “We need a stronger turnaround in real estate values and stronger appreciation,” says Schwartz. “That will lead to higher transaction volumes, because buyers will have confidence in the market and sellers can realize a big enough margin to motivate them to sell. Appreciation will come from an increased demand, as higher demand means higher rents and higher rents mean higher property values.  

On the leasing front, people occupying buildings are also hesitating, trying to get clear signals about whether they should expand their businesses. “That’s abated over the last year, though,” says George.

“People with leases coming due have made the necessary cuts—reducing operating costs, staff and inventory, managing vendors more efficiently—and are preparing to make decisions,” he adds. “It’s taken companies a couple years to stabilize.”

And the market needs to absorb excess vacancy before new projects get built. “It’s worse in certain areas of the county. In the outlying suburbs there’s a lot of vacancy in class A and B office space,” says Cegelski, “whereas, downtown, class A office space is particularly strong.”

For Dines Inc., the perception that downtown is overbuilt is an issue. “Even though we’re almost completely sold out of some inventory in certain price segments, particularly in the luxury/lakefront market, banks are very hesitant to loan on any new condominium projects at this point,” Dines says. “We opened 2012 with just under two years of condominium supply downtown and it will likely take three to five years for any new projects to be ready for occupancy.”

And although historically low prices are a boon for buyers, that’s not so for sellers or landlords. “Supply continues to outweigh demand and unemployment rates remain stubbornly high,” says Machotka. “It all points to a slow recovery for real estate.”

That perception of very slow improvement makes people act very conservatively. “A lot of people who have lost properties through foreclosures or other distressed situations won’t be back in the market for a while, so that pool of buyers is gone,” Jesse says.

People need job security to make big purchases like real estate. And they need a place where they can get a loan, whether it’s for a home, a business or a commercial investment, Schwartz notes. “The more reliable this support network becomes, the more recovery we’ll see.”

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