PRINT THIS STORY:

CHANGE TEXT SIZE:

Will late '90s capital boom lead to late '80s-style bust?

By Phyllis Feinberg

"It's different this time; no, really it is," was the headline on the Dec. 26 weekly report of Paine Webber's real estate investment trust research group. Even though huge amounts of capital are again flowing into the commercial real estate industry, the boom-and-bust cycle of the late 1980s won't be repeated, the Paine Webber report assured.

"We don't think the amount of overbuilding that took place in the 1980s will occur now," Gary Boston, who follows the retail REITs for New York-based Paine Webber, told SCT. There has actually been a slowdown in the construction of retail properties, from about 200 million square feet annually in 1995 and 1996 to about 158 million square feet in 1997, he said.

"The money coming into the sector is being used for acquisitions," said Mr. Boston, noting that about $5.8 billion in acquisitions were announced in 1997, compared with about $1.9 billion in 1996. This figure includes the $1 billion acquisition of a 12-mall portfolio owned by the IBM Corp. pension fund by Indianapolis-based Simon DeBartolo Group and Macerich Co., Santa Monica, Calif. The deal was announced Dec. 29, and is expected to close this month.

And how can the shopping center industry be so sure it's not heading for another crash? "We have much better information now than in 1988; if the market sees that there is overbuilding, the money spigot will be turned off," Mr. Boston said.

But despite Paine Webber's assurances, many people involved in the real estate markets think there could be problems on the horizon. Even officials at Nomura Capital, New York, which has been one of the major sources of funds for the real estate industry, express some concern.

"There's an awful lot of money out there. A lot of people are pushing the edge of the envelope," said Stuart Silverberg, a director of Nomura. "There will be people who make bad loans and get burned."

But Mr. Silverberg was quick to defend Nomura against claims that the firm has been doing some envelope-pushing of its own. "We are doing deals in an innovative format and feel we have security. We're taking an equity interest in some deals through convertible stock, which provides more safety."

Nomura has been active in the growing value-oriented shopping center area, financing and participating in several projects with Glimcher Realty Trust, Columbus, Ohio, such as the SuperMall of the Great Northwest near Seattle.

Last year Nomura also did two of its trademark "megadeal" securitizations of mortgages, each of which was worth close to $1 billion.

Nomura Asset Capital is scheduled to be spun off by its parent, Nomura Securities Co. of Japan, in April. It has already found a partner to share some of the risk from its real estate deals. New York-based Morgan Stanley Mortgage Capital Inc., a subsidiary of Morgan Stanley, Dean Witter, Discover & Co., has agreed to provide $3 billion to finance the company's loans on commercial properties. In return for providing the line of credit, Morgan Stanley will be a joint lead manager of the first two of its bond offerings.

According to Ethan Penner, who heads Nomura Asset Capital and will be CEO of the spinoff, the first two offerings will be the largest commercial mortgage-backed securities (CMBS) deals ever issued, with a combined value of more than $5 billion.

Other investment banks are vying to get a piece of the CMBS action from Nomura. This also fuels the concern about the quality of new deals.

"There's so much money available now, but underwriting standards are holding up," said Gregory Spevok, an associate director at Bear Stearns, New York, which is closing real estate loans at the rate of about $120 million a month. About 35% of the volume is for retail properties.

"We've increased our volume five-fold in a little over a year and anticipate it doubling next year," he added. Most of Bear Stearns' loans are in the $3 million to $25 million range, according to Mr. Spevok.

Observers point out that many of today's deals are refinancings of existing debt, with the loan essentially being transferred from one firm's books to another's.

"Interest rates are so low now that companies refinancing lines of credit can save 40 to 50 basis points," Paine Webber's Mr. Boston said, noting those savings can have a positive impact on a REIT's funds from operations.

Lenders are much more aggressive today and are competing on two fronts, said James Titus of Donaldson, Lufkin & Jenrette, New York. First, they are competing on interest rates, with spreads being much tighter, and are making much larger loans, with higher loan-to-value ratios, he said.

"I've never seen more liquidity in the real estate market," said Mark Finerman, a managing director of Credit Suisse First Boston, New York. Credit Suisse did $7 billion of mortgage originations in 1997 and sold two large CMBS securitizations with about $1.5 billion of mortages in each deal.

Mr. Finerman said he thinks the retail real estate market is sound.

"There's a lot of information available on tenants, especially the larger ones," he said. "I don't see the rapid expansions of the mid-1980s. I don't see people developing complete spec retail projects.

That makes today's market different from the last real estate cycle, he said. "Most of the deals are being done in the public markets, and when you use the public markets there are stricter standards."

Real estate investment trusts also have had a greater discipline forced on them by the public markets, observers say.

"The requirements for maintaining investment-grade ratings on unsecured debt have forced some retail REITs to have a more conservative capital structure," said Lisa Sarajian, an analyst in Standard & Poor's credit rating division. However, she too notes that "there's a lot of capital out there, and in the retail sector there has been a lot of construction."

In an effort to maintain investment grade credit ratings, Ms. Sarajian said some REITs have forged joint ventures and done "off-balance sheet financing" to pursue more highly leveraged construction projects. "If a joint venture is conservatively financed, the off-balance sheet financing is not going to hurt."

The rating agencies are also forcing discipline on the CMBS market. They rate the CMBS pools of debt; this ensures that all issuers adhere to some standard underwriting criteria, observers note.

There has also been a bull market for secondary equity offerings, another source of capital for the retail REITs, which sold more than $4 billion of stock in 1997.

Paine Webber's Mr. Boston believes that the huge amount of secondary stock offerings may be one reason retail REIT stocks did not perform well in 1997.

DLJ's Mr. Titus doesn't expect any negative fallout from all the financing over the near term. However, he doesn't think that the real estate industry can escape an inevitable cyclical downturn.

"Below-investment grade classes of CMBS deals -- BB and lower -- will be the first to be affected by a downturn," he said. Investment grade-rated deals also could be at risk, "But that's years away from now."

The retail area is particularly susceptible to a downturn, he believes. Retail real estate "never experienced the same bounce-back as other asset classes of real estate," he said. Despite the availability of capital, "Retail [REIT] returns have been flat, at best."

Nomura's Mr. Silverberg thinks owners and lenders may be able to make adjustments in the next downturn. "Properties can be recycled," he said.

Meanwhile, development still can be a slow, painful process. "There are some projects that have been on the drawing board for some time and are still struggling," he said.

But for good projects -- and for some that are not so good -- the money is available. It remains to be seen if that's a good thing.