Costs Soar, Market Cools, But Lenders Still Hot for SF Condo Construction

By Lizette Wilson
SF Business Times

Bay Area condo construction is still the darling of lenders, although the romance has soured in other parts of the country, notably Miami, Chicago and San Diego.

There, hundreds of units have sat unsold on the market for three months or more, prompting lenders to back away from fresh projects. But the Bay Area, and San Francisco in particular, is still a sweet spot for more highrise development.

“It’s been very pro-borrower and it’s gotten more so — now the insurance companies are getting involved. They’re falling all over themselves to throw money at people,” said Tim Mahoney, a vice president of CB Richard Ellis Melody Capital Markets, who serves as a loan intermediary. Mahoney said he gets about a call a week from insurance companies offering new construction loan programs.

“Prudential, New York Life, Principal Financial … they are all offering construction loans. New York Life is offering it now where they weren’t for 10 years.”

The passion for condo construction lending is unusual, given national trends pointing toward a cooling housing market and increasing difficulties for condo developers. Construction materials, including dry wall, glass and concrete, have increased roughly 30 percent over the past year, while skilled labor is increasingly tough to find and costly to procure.

If eager condo lenders are unusual, so, too, is the market in San Francisco.

Unlike Miami, where an estimated 60,000 units are in the development pipeline, San Francisco is constrained geographically. Less than 8,000 units are slated for completion within the next few years, and additional development sites are limited. The Palms, the Watermark and the Beacon, the only three projects where new condos are for sale, all report record activity in January and February, traditionally the slowest time for homebuyers. Since Jan. 1, the Beacon has averaged nearly one condo sale a day.

New development sites are largely limited to Rincon Hill, SoMa and Mission Bay area — spots that are, in many cases, already spoken for.

The lure of a constrained development market and strong owner demand for new condos prompted Dean Givas to open IntraCorp San Francisco last year.

He recently closed escrow on two properties; 55 Page St., where he intends to build 128 units, and 300 Berry St. in Mission Bay, where he plans to build 268.

Givas said although short-term interest rates have gone up somewhat, overall lending conditions have changed little since he began seeking financing for both projects 10 months ago. IntraCorp has selected JP Morgan as its equity partner and has term sheets now with an unnamed German bank for both projects.

IntraCorp Vice President of Finance David Herron declined to detail terms, citing confidentiality agreements, but said his experience was a good one and he’d be surprised if other developers weren’t also enjoying a fair to favorable share of power.

“While I’m not privy to the terms other developers are getting, the lenders people work with are in a fairly narrow band.” He added: “Our negotiations have been on a level playing field. We’ve asked for very rational things and we’ve gotten them, as have the banks. The discipline in the underwriting has not changed.”

The one thing that has changed, according to Givas, is the number of lenders courting condo developers.

“Maybe it’s seven out of eight lenders that now want to lend on condos, where before it was eight out of eight,” said Givas. “We haven’t see any of our term sheets change, though.”

Michael Watson, first vice president of commercial real estate for HSBC USA, which is providing the construction loan on Millennium Partners’ tower of 260 units at 301 Mission St., agreed that although lending is cooling in other markets, San Francisco continues to be a hot spot.

The constrained supply and high-income level of potential buyers make it one of the most desirable — and successful — places to develop luxury condos. The global recognition of the city also brings international lenders, which provide increased competition for regional and national players.

“I would say the balance of power is definitely not to the lenders,” he said.

Two market forces could shift that balance, however: further construction cost increases and weak demand for new product.

Andy Ball, CEO of Webcor, has built or begun work on a half dozen residential projects in the past 18 months, including the St. Regis tower, 300 Spear St. and 301 Mission St.

He sees a slowdown ahead.

“As construction prices continue to go up, and I think they’re going to continue to go up because of materials costs and constrained labor, there are some projects which are just not going to make sense. Lenders are going to see that,” Ball said.

Indeed, lenders have had to rewrite terms frequently during the past year as construction costs increased and the loan amounts changed.

Jeff Eliason, a senior vice president with real estate investment bank Buchanan Street Partners, said rising construction costs have pushed him to rewrite loans “at least 50 percent of the time” on current projects.

He said price increases have not been enough to kill any of the projects, however — just find new lenders in some cases.

As for housing demand, buyers are still sweet on owning a home in San Francisco.

Despite prices climbing to a $722,000 median price in January, 335 buyers purchased homes in the county last month, according to DataQuick, a real estate research group.

Although that’s 20.8 percent less than the same period last year when 423 homes sold, it will take several more months of data to determine whether a slowdown is officially under way.

As long as the unsold inventory remains low, meaning new units do not stay on the market longer than three months, lenders say they are likely to continue to enthusiastically court condo developers.

Said Vern Padgett, manager of the real estate industries group at Mechanics Bank: “There’s too much money chasing too few high-quality deals right now. If you want to be in the game, you have to be more aggressive in terms. You have to accept less equity and lower release pricing” for the condo units

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