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Tuesday

September 2014

2

Developers need all right pieces

Builders, lenders explain new approaches to development

Are we creeping out of the development halt that came along largely as a result of the recession? Or will the dirt in Lake Country remain undisturbed by a contractor's shovel for a bit longer?

Some developers are saying they're ready to start new projects, but the banks are tight and not offering any financing. It seems that only the bigger players hold the needed tokens to pursue development. When others might join the game is still uncertain. On the flip side, banks claim they're ready to lend, but no one is applying - and new lending regulations have severely changed lending practices.

The national forecast shows even more proof of a slow uptick in the onset of new construction. Housing remains the weakest part of the U.S. economy, analysts say. Sales of new homes have fallen 18 percent in the two years since the recession ended.

Analysts said the reports served to highlight the fed's decision last week to cut its economic outlook for growth and employment this year. It also supports worries expressed by Federal Reserve Chairman Ben Bernanke that many of the economy's troubles could last into next year.

Whether lending or development slowed first seems like a chicken-and-egg scenario. We asked a few local experts in each industry to weigh with their thoughts.

No need for new space

A spokesman from a local bank, who asked to remain anonymous, said one of the reasons there is still a lack of new building is because so much unused space remains.

"Ultimately what's happened is there is a lot of inventory and not the need for someone to set up a new office building to be leased out. We see a lot of owner-occupied (buildings) requesting expansion, but there's still a lot of vacant property," he said.

Waukesha State Bank President Ty Taylor asked what sensible person would build commercially right now with so much inventory on the market. He also expounded on how federal regulations are at a historical extreme. The unnamed bank spokesman said that a few years ago, money was cheap and there was rapid growth. "There was land out there, and things kept appreciating. Banks were in growth mode, and so they changed their underwriting standards to look at it as an investment. We wanted to grow our balance sheets, and we took on condos, subdivisions and retail centers," he explained.

He said that, historically, the accepted formula was about a 33-, 33-, 33-percent divide, with the borrower putting up 33 percent cash, the lender putting up 33 percent and a 33-percent expected return. "But that got all skewed because borrowers were leveraging to buy land and then borrowing to do improvements," he said.

He said regulators came down on banks that had exposure to developments, and a lot of money was lost. "So when developers say we're not lending, it's true, but there is no market demand, and expectations have gone up to historical norms," he said.

Taylor also said many don't understand that even though your loan is handled by a local entity - like Waukesha State Bank - most of them are sold to Freddie Mac and Fannie Mae.

"If you have a home on a 30-year, fixed-rate mortgage, no matter what bank it's with, the mortgage has been sold to Freddie Mac or Fannie Mae. Then we get blamed when they come out with these new rules. It's not coming from us, it's coming from Freddie and Fannie, and, granted, a lot is appropriate, but a lot of what they're asking for just gets passed on to the borrower," he said of the increased costs of doing business because of more regulation.

The anonymous banker said most businesses have trimmed the fat on their operations in the last couple of years. "A lot of these guys are scared. They have looming health care (costs), looming regulatory costs and tax code changes. Unless they're really humming along and need to expand, they're not going to do it. The alternative is to find space to put the company in, and there are a lot of vacancies," he said.

There are tools out there

Stu Wangard of developer Wangard Partners said the winning formula for his company's current residential development is favorable interest rates, moderate construction costs and good prices on land. Wangard said these things spurred his company's decision to begin construction on the luxury apartment development Preserve at Prairie Creek. The 200-plus-unit development at Highways P and Z in Oconomowoc will serve demand in Lake Country from baby boomers looking for second homes here while they have seasonal homes somewhere else.

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Bill Niemann, Pabst Farms development executive vice president and general counsel for the development, said optimism is high that things are going in the right direction at the multitiered Pabst development, which includes residential and commercial offerings.

"We have proceeded to construct models at Village Crossings and had a successful grand opening with more than 120 household (close to 250 people) show up," Niemann said of the condo development.

Niemann said Pabst had the unique advantage of already being under development when the economy went sour. He said a relationship had been established with the City of Oconomowoc, and the development has continued to enjoy a strong relationship with lenders.

He said there is no denying that the economy has had an effect on Pabst, with the most obvious victim being the regional mall. But he said it's still not a matter of if it will be built but when.

"I think developers that don't have infrastructure in the ground will have a harder time. We, together with the city, have been able to continue the vision for Pabst Farms and have been able to complete all the backbone infrastructure to make the development accessible for those businesses and residents that want to move here now," Niemann said.

While Wangard is already seeing interest in its new Oconomowoc residential development, it's enjoying a 90- to 100-percent occupancy rate in many of its commercial properties. Wangard said the vacancy problem in today's economy doesn't apply to his higher-end office spaces. Amenities there make a commercial development successful and will be what his company continues to pursue, he said.

However, Jon Spheeris, president of Prudential Absolute Realtors in Oconomowoc, painted a picture that more developers might relate to today. He said most local banks he's spoken to have said they are not doing development loans because they are now considered "classified" or bad loans by federal regulators.

Spheeris also said that from his vantage point, not many developers are out there looking to do new developments because - as one banker said - "the demand is down, and the risk is very high for a low reward."

"Why would a developer take the risk as the rewards are so low, considering the risk?" said Spheeris, who was involved with the Village Square development as well as several residential projects in Lake Country.

Popular lending

Taylor said Waukesha State Bank has always done a majority of its lending to nondevelopers, "people that have service businesses like manufacturing. It's not as robust as I'd like to see, but it's definitely improving. And we love doing business loans - small-, medium-sized businesses," he said.

Taylor said federal regulations don't have as much an effect on business lending, "so that's a positive."

He also said the bank continues to do a lot of home-equity lending. "Rates are awesome. If your home value has gone down, but you want to buy a bigger house," now is the time, he said.

He acknowledged that most people will be downsizing instead of upsizing, and many are still just waiting it out to see whether home prices will drop even more.

Secrets to success

Wangard said even when the economy was at its worst, around 2008, his company continued to stay busy. How were they able to continue planning and developing?

"A secret to our firm is we do leverage as high as anyone else does, but once a project is complete and cash flows are stable, we quite often bring in investors. When they come in, we pay down our debt so we are at a lower risk profile and always make sure we have adequate resources to take care of things we cannot predict.

"We have learned to save for rainy days and have consistently reinvested our company and our projects to make sure where our funds are being spent is somewhere important," he said.

When will it change?

Spheeris said he's not interested in any project unless it is owned by an individual who has financing in place, similar to Wangard or Pabst. "The demand for commercial developments is down again due to financing unless there is an end user," he said.

Spheeris said all his projects are on hold, and even if you have the cash to invest in a project, banks are still leery of loaning money on any development.

To get development off the ground for everyone, it seems like banking regulations would have to make a dramatic shift back to less-restrictive rules, as they were years ago. Based on current legislation - which Taylor said keeps growing - it's not likely to happen soon.

The Associated Press contributed to this report.

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