COVER STORY, APRIL 2008

GOOD PROJECTS STILL GET GREEN LIGHTS
Texas’ strong economy makes it possible for new real estate projects to receive financing.
Tim Loudermilk

Tim Loudermilk, Texas Capital Bank

The good news is that Texas is a very good place to do business. Unlike other areas of the country, the Texas economy is currently strong, the economic outlook for the state remains positive and profitable real estate opportunities still exist largely because of steady job growth throughout the state (Texas led the nation in job growth last year). The state’s real estate market is in relatively good shape because it avoided most of the excesses that are causing problems in other states, where oversupply and the subprime mortgage fallout are having ripple effects throughout their economies.

So what does this mean to developers and investors who want to finance upcoming projects in Texas? In a nutshell, it is still possible to get new real estate projects financed in the state, however the requirements are more stringent. Overall, there are three trends that currently are prevalent for Texas real estate financing: local market experience is a must; local money is the best source of equity capital; pre-sales and pre-leasing along with other requirements are needed to secure financing.

Those who are best positioned in Texas real estate today are the local people — those who know their markets firsthand. There is no substitute for developers and lenders who have experience in the state and have witnessed the state’s previous economic cycles. Lenders are paying more attention to the experience level of borrowers and their development teams, wanting to see engineers, architects, brokers and general contractors who have years of experience in Texas. For example, reports from Austin indicate that developers who are now trying to enter that market face many obstacles in getting their projects financed.

Local developers who didn’t take on substantial risks during the past few years have an even greater advantage; not being over-leveraged gives them more leeway now to finance new projects.

Local Money is Best Bet

Consequently, local and regional banks are best positioned to take advantage of current marketing conditions. National financial institutions operating in Texas have reportedly put moratoriums on real estate lending for the near future because of bad economic conditions they are facing in other states. Long-term financing sources are materially disrupted and somewhat less capital is available throughout the state.

Texas banks that maintained strong credit policies during the past few years continue to make real estate loans now because they aren’t dealing with bad loans on their books. After all, consistent credit policies that don’t change with the whims of the market will best serve Texas developers and lenders moving forward. It is strong credit and lending policies that prevent bad deals from getting done that can bring down a market.

Despite the lending constriction, competition for deals remains strong in all major Texas markets, with local and regional banks offering the best options. For example, Fort Worth has an enviable financing climate right now because of its healthy business climate and new wealth being created by the Barnett Shale natural gas field. The market is seeing more capital chasing available opportunities, causing banks to compete for the top-tier deals. However, the credit market overall in Fort Worth is tighter than a year ago. Seasoned bankers are more in tune with the risks of a deal versus the return provided the bank in interest on the loan.

In San Antonio, the local and regional banks are still active in real estate, as they are more knowledgeable about the city’s quality locations. Banks there are willing to finance quality developments and anticipate more requests in 2008 due to the credit availability tightening in the short-term and long-term markets. Austin, Dallas and Houston report similar situations — local and regional banks will still finance deals that make sense.

Financing Requirements

Throughout the state developers, lenders and investors are being more conservative in the projects they’re undertaking. All major markets are reporting more stringent pre-leasing or pre-sales requirements. Under current market conditions, banks may require as much as 60 percent of a commercial project committed to tenants before approving a loan. Less than prime areas may require even greater pre-leasing.

The income stream for commercial developments is now even more important in the loan application and approval process. Good income-producing property with a locally experienced developer in the right location will still most likely receive funding. However, borrowers should expect a bank to scrutinize the economic feasibility, site, location and plans more closely, as well as require greater partnership equity.

The Houston market is seeing this. Despite being home to a burgeoning energy industry and growing medical center, the financing market there has tightened as national lenders have stopped making real estate loans. Lenders are requiring borrowers in the market to have larger equity commitments in their projects.

What’s Working, What Isn’t

The types of projects most likely to get funding are as diverse as the state itself. What works in one market doesn’t always work in another. However, there are a few common denominators. Mixed-use and multifamily developments are highly attractive, as well as redevelopment of aging properties.

Infill development is important in most of the state’s metropolitan areas. Austin has made its downtown vibrant, with multifamily development increasing the area’s population, which in turn continues to create redevelopment opportunities. In Dallas, developers are tearing down aging properties in the city’s close-in neighborhoods and building mixed-use and multifamily projects. Locations near Dallas’ light-rail transit lines are especially popular. Fort Worth’s renowned Cultural District is seeing new projects as people want to work, live and play in the area. Class A apartment buildings inside Houston’s Loop are going up and mixed-use projects are clearly a bright spot under the current lending and development constraints.

Of course, areas with a constricted supply are in high demand for all types of real estate development. For example, Dallas’ Uptown area adjacent to downtown remains strong with continued building of office buildings and multifamily units. In Houston, retail, office and apartment projects located in the close-in areas of Midtown, Heights/Washington Avenue, the Galleria/Uptown, Kirby and Greenway Plaza are doing well. Also in the Houston market, master-planned communities such as Sugarland and the Woodlands remain strong.

A weak spot is single-family housing, which has slowed significantly throughout the state. The bright spot is Austin. Although home sales have fallen somewhat, builders have done a good job of policing themselves so there is not an oversupply of homes currently on the market. In fact, home prices and apartment rental rates are still increasing.

Conversely, the slowing housing market is creating opportunities in rapidly growing San Antonio. Construction of single-family homes has decreased because of an increase in the resale market and the oversupply of new homes. But local and regional developers are seeing land plays as the national developers who stockpiled land have pulled out of the market.

This diverse market activity illustrates that the Texas real estate market remains strong and viable despite some slowdown in a few sectors. With the changing environment comes changing financing requirements. The good news is that opportunities still exist for all the players, especially for developers with good local market experience, income-producing potential, the right location and a local bank lender.

Tim Loudermilk is executive vice president of Texas Capital Bank. Also contributing to this article were Texas Capital Bank executives Douglas Cotner in Austin, Jeff Moten in Fort Worth, Elaine Opper in Houston and Laurie Griffith in San Antonio.

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