COVER STORY, JANUARY 2009

HOLDING STEADY
Doing business in Texas still looks good.
By Leonard R. Smith

Smith

The financial meltdown is a global crisis of significant magnitude, affecting communities across the world. However, while most of the United States is suffering from the effects of declining property values, foreclosures and bank failures, Texas has yet to experience a drastic decline and remains fairly stable. All four of the state’s major markets (Austin, Dallas, Houston and San Antonio) have maintained high levels of performance across all property types. Although Texas lenders, like those in other parts of the country, are affected by the uncertainty of the capital markets, most local and regional Texas banks appear willing to lend on nearly every property type (with the exception of residential condominiums), albeit at far lower leverage than in the past. Financing is possible, but it is more expensive, underwritten more tightly and requires more equity.

Among the various property types across Texas, multifamily has outperformed the bunch. As a result, multifamily financing for development, acquisition and refinancing is the easiest to obtain. Given the present environment, the HUD, Fannie Mae and Freddie Mac programs are the most attractive to borrowers. Each offers non-recourse, higher leverage, fixed rates, and longer terms and amortization, as opposed to the conventional programs. The various HUD programs offer 90 percent loan-to-cost (LTC) and 40-year amortization for development, and they offer 80 to 85 percent loan-to-value (LTV) and 35-year amortization for acquisition and refinancing. Fannie Mae and Freddie Mac offer financing programs for acquisition and refinancing up to 80 percent LTV for 30 years with rates in the low-to-mid 6 percent range All three programs require 90 percent occupancy for 90 days for either refinancing or acquisition.

As one example of the overall condition of the Texas market, the Houston commercial office segment is experiencing high occupancy (88 percent) and strong growth in supply and absorption. Presently, approximately 10 million square feet of office space is under construction in the MSA. While the other three major Texas markets are not enjoying quite the same volume of growth as Houston, they too are strong. Also, the retail and industrial sectors are experiencing high levels of occupancy and absorption rates. Financing for development, when available, will be at lower LTC, full-recourse and require a high percentage of pre-leasing. Financing for acquisition and refinancing is available, albeit at lower LTV and full-recourse. 

The Texas hotel segment is performing very well, although industry experts forecast a 4.3 percent decrease in RevPAR in 2009, with a modest recovery of 3.2 percent in 2010. Development financing for even the strongest brands is difficult, if not impossible, and, when available, it’s at full-recourse with a lower LTC (50 to 60 percent) and a shorter term. Financing for acquisition and refinancing is obtainable but, as with development, only for the well-performing, stronger brands, at full-recourse and at a far lower LTV (60 to 65 percent) than in the past. Additionally, it will require a debt-service coverage ratio (DSCR) in the 1.5 to 1.6 range. Only financially strong, experienced owners and developers will be able to obtain financing for either development or acquisition, and refinancing.

Hotels, commercial office, retail and industrial properties have all seen an increase in cap rates, with hotels experiencing the most dramatic rise. The cap rate increase is the result of three major factors — increasing interest rates, expectations of declining cash flow growth, and more supply raising the level of risk. Overall, multifamily has experienced only a slight cap rate increase due to high occupancy, strong rental rates and the availability of attractive financing. As with multifamily, commercial office space is benefiting from strong occupancy and rental rates, albeit less attractive financing and a modest increase in cap rates. The amount of vacant retail space and availability of financing has pushed these cap rates higher than what has been experienced during the past several years. As mentioned above, hotels have seen the greatest cap rate increases of all. The following two charts show the decline in transactions resulting from what has occurred in the capital markets and the gap between the sellers’ asking prices (based on former cap rates) and a viable purchase price for buyers.

Texas is in a fortunate position. While many parts of the country and world are facing significant challenges as a result of the current economic crisis, Texas remains a strong and diversified marketplace with room for opportunity. However, the rescue effort is still in the early stages, despite the billions of dollars pumped into the global financial system to ease the credit crunch. As a result, there is a growing sense that the protracted credit crunch will continue to swell the number of loan delinquencies and defaults. A large percentage of the more than $700 billion dollars allocated by TARP will be used to shore up the nations’ banks to help meet their necessary capital requirements and, subsequently, will not flow out into the market. So while financing is possible, it is more expensive, underwritten more tightly and requires more equity. 

These are unprecedented times. Fortunately, we live in Texas.

Leonard R. Smith is senior vice president with Aries Capital in Houston.

©2009 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.