While the 2011 Survey of Northeast Ohio's Construction and Real Estate Industries has shown some positive signs in terms of financing in the real estate realm, it is still one of the major concerns revealed in this year’s survey. Additionally, many respondents are feeling the cash flow pressures created by vacancies and a lack of demand. Despite these difficulties, respondents are more confident now than at any other time since the start of our survey that there will be more real estate opportunities in Northeast Ohio in the next three years.
Despite the problems that many respondents are having obtaining financing, looking at the last four years of survey data, it seems as though 2010 may have been the bottom of the credit crisis and that lender demands are easing up a bit. This year’s survey found 81% of respondents were seeing equity demands of 30% or less. That was quite a jump from the only 52% that were seeing the same equity demands last year. Also of note, only 5% of respondents last year saw equity demands of less than 20%, while this year that number rose to 23%. Based on the results, it looks like we are nearing 2008 financing levels, but we are not quite there yet.
Regarding how new construction and acquisitions are being financed, national and regional banks made a big jump this year compared to alternative financing sources. In 2009 and 2010, only 43% and 33% of respondents were turning to national banks for financing. This year, that number leapt to 69%. Regional banks rose to 50%, as well. Also, private equity was used by only 38% of respondents, compared to 50% last year. This is a good indication that banks have been more willing to lend this past year, if the deal is right. One other note of interest is that more respondents (38%) were taking advantage of tax credits, TIF and other public funds as financing sources this year.
As there was an increase in using conventional banks to finance transactions, there also seems to be an increase in lender stability. During the previous two years, about half of our respondents were considering their current lender when refinancing their existing mortgage. This year, 73% of respondents are expecting to stay with their existing lender.
While it seems as though banks have once again resumed lending, the loans that they have been approving have been on much more stringent terms. This continues the trend of the last few years of increasingly stringent terms. In 2009, 2010 and now 2011, approximately 80% of respondents said the loan covenants were more stringent each year. While deals are getting done, it only seems to be the best of the best that are meeting these increasingly stringent terms.
So when do our respondents think that credit markets will finally return to their previous levels? 2012 was the most common answer with 58% of the respondents.
Getting Deals Done
What are the biggest concerns for getting a deal done? Last year’s poll revealed that “credit” was the top concern of respondents. This year, “credit” dropped to number two in favor of “property valuations,” up from third last year. Last year’s second choice, “equity funding,” dropped to number three this year. One respondent was feeling pressure from multiple issues. They said, “Since we are primarily a residential real estate business, the tightening of loans and the decreased valuations of properties are the most significant challenges that we currently face.”
One obstacle that was not stopping our survey respondents from getting a deal done was interest rates. Ranked as the fourth or fifth concern (out of five) by 82% of respondents, interest rates do not seem to be a make or break for many deals.
Dealing with Cash Flow Concerns
Cash flow is still a major issue for the real estate industry. In 2009, 32% of respondents said that they did not have enough current cash flow to support existing properties and projects. In 2010, that number rose to 41%. This year, the number has risen once again to 45%. How are respondents coping with this troubling trend? The most common method was “accessing existing liquidity,” which 36% of respondents chose to do. This was up from only 24% last year. The second choice was “attempting to sell assets” with 32% of the response. This was a slight decrease from 35% last year.
One participant summed up why, with reduced cash flow, vacancies have become such an important topic. “Our greatest current challenge is converting the limited number of prospects available into tenants. Downward pricing pressure and increasing incentives by competitors are leading to deals that are unreasonable, but almost impossible to pass up. If you don’t close a prospect, the next one may have similar or less favorable terms, and you’ve had carrying costs for the 3-6 months until they come along.”
“Vacancies” were a common response to the question, “What is the greatest challenge that your company currently faces?” One respondent described the challenge as “higher vacancy rates, discounted rents and increased operating expenses.”
So, how are respondents dealing with vacancies? “Lowering rents” was selected by 56% of respondents and was, once again, the most popular option (down from 68% in 2010). Forty percent of respondents said that they would also “increase marketing” and “enhance tenant amenities.”
Seventy-six percent of this year’s respondents said that rents are currently decreasing in the market. The number dropped from 85% in 2009 and 83% last year.
Cost Cutting Measures
With the cash flow issues stemming from the increased vacancies and downward pressure on rents, many respondents have turned to cost cutting measures over the past several years. Respondents were asked about payroll, marketing, employee benefits, professional services and discretionary expenses. The results were somewhat surprising this year. In four of the categories, respondents cut less frequently than in the past two years. For instance, 60% cut payroll in 2010 while 2011’s percent dropped to 38%. Similarly, professionals service fees were cut by 40% of organizations in 2010 and only 23% in 2011. As another sign that organizations cannot cut core expenses any further, the one category to show a rise from last year was “discretionary expenses.” This was cut by 92% of respondents in this year’s survey.
Reasons for Optimism?
Despite some of the negative takeaways from the survey, it certainly shows reasons for optimism as well. When asked, “In the next three years, do you see your business having more, less or the same amount of opportunities in Northeast Ohio,” respondents seemed to have a very positive outlook. From 2008-2010, 55%, 46% and 72% felt there would be more opportunities in the next three years. In 2011, that number jumped to 81%. Additionally, only 4% of respondents felt that there would less opportunities.
One respondent gave his thoughts on the source of the upcoming demand. “Northeast Ohio still does not appear to be desirable to commercial real estate markets. Our new work is driven by industry gearing back up, low income housing and housing demolition, and government subsidized projects.”
Another respondent seemed to sum up the optimism rather well. “I believe that overall the market is looking better. However the significant oversupply in most sectors will continue to dampen enthusiasm for new construction for some time.”
Green Building and Building Information Modeling
According to our survey, green construction is showing growth, despite the fact that 57% said that it has had little impact on their business. This year, we saw some growth in the answer to the question, “What percentage of your projects over the next year do you believe will be at a minimum LEED certified?” In 2009, 25% of respondents felt that more than 25% of their projects would be LEED certified. This grew to 27% in 2010 and rose again to 32% in 2011. This increase could be due to another increase in the answer to, “Has LEED certification improved the marketability for buildings within your portfolio?” While last year only 19% said yes, the number rose to 27% this year. As these properties continue to grow in marketability, we’re sure to see an increased trend toward Green Construction.
Building Information Modeling (BIM) Software is another area likely to see future growth. While only 23% of respondents see BIM currently impacting their business, 50% believe that it will have an impact in the near future.
This year’s survey revealed many areas of concern for the industry, such as a lack of cash and issues with vacancies and demand. Despite these issues, many respondents are optimistic about future opportunities in Northeast Ohio. Next year’s survey results should provide the clearest indication yet that we are in the midst of a recovery.