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\'The Slow No\'

September 10, 2001

By Kathryn Maese

Downtown Residential Developers vs. Lenders Blackballing or Good Banking?

Major banks and other lenders are nervous to the point of being reluctant to invest in Downtown urban residential projects. At least, that's the view of developers who complain that lenders are dragging their feet to finance projects. The result is that many business and real estate leaders fear for the long-term viability of the Downtown building boom at a time when the city core can least afford it.

On the other side of the issue, the lenders see--in the words of Komerica Bank's Vice President for Loans Phillip Delora--"a bunch of fly-by-night projects to convert dead office buildings by people who are just dialing for dollars."

Little wonder, given this deep divide, that so much Downtown housing is planned and so few projects are completed.

Take, for instance, what happened in late March when nearly 500 developers, real estate leaders, engineers and financiers descended on the Urban Land Institute's "Urban Marketplace 2001" conference at the Biltmore Hotel's Crystal Tiffany Room. All were eager to glean the latest about L.A.'s inner-city development--in sharp contrast to only a few years ago when the idea of Downtown urban living was considered too risky to be taken seriously.

The day-long gathering was unprecedented because of the sheer numbers of people. Here were developers eager to get in on what many considered to be the last great urban opportunity where empty buildings were plentiful and demand for loft living high. And, from the turnout at the conference, it appeared that the banks and lenders were just as eager to finance these projects judging from the scores of business cards exchanging hands.

But the morning-after reality was a different story altogether.

According to residential developer Frank Gamwell, chairman of PCM and partner in Oxford Street Properties, despite the dozens of financial contacts he made during the conference, in the end he encountered "The Slow No," which he explains is the "20 to 30 phone calls it took just to make an appointment or get someone to talk with him at lending institutions."

Complains Gamwell: "Every single bank thinks they are looking after this market, but they're not. There is a lot of difficulty in getting financing for projects."
But the lenders tell a far different story: "I certainly promote more dialogue between developers and financing communities. But we have a responsibility to be fiscally prudent. That doesnt mean we wont take a chance, but we will do everything to mitigate risk," says Fannie Mae's Los Angeles Partnership Office Director Barbara Zeidman. "Some of the whining you hear is from new developers who come to us with wish projects."

Komerica Bank's Delora is even blunter. "We don't bank projects, we bank relationships. When those relationships show up, we do business. When some bozo shows up with the best project and I don't have relationship with them, I pass.

"The only customer I want is someone who banks with Wells Fargo, Sanwa and others like them," he adds. "As it turns out my office just closed on the Medici project."
The question remains: Are lenders really all talk and no action? Or does the truth lie somewhere in between?
On the one hand, experts are saying that Downtown is the one place in overbuilt L.A. where growth is not just inevitable but also relatively unaffected by the current economic downturn. Some developers point to the fact that similar efforts over the last 15 years to rehabilitate urban areas with housing during times of economic slowdowns have been largely successful.

Contrast that with the reality of most Downtown developers who have struggled to put together a financing package for their residential project only to sit by the phone waiting and wondering. A certain degree of paranoia among them becomes understandable. "One of the annoying things about being a developer Downtown is that you get the feeling you are being blackballed by the financial institutions," developer Mark Tolley, Urban Pacific LLC., explains. "When push comes to shove, the dollars just don't come in."
Yet lenders assert they act on each application after weighing all the factors, from a developer's reputation to market demand. There is no red-lining of urban areas, no bias against Downtown, they claim.
So who's right? Both sides, apparently.

"Basically, it boils down to risk and return," says Stuart Gabriel, director of the University of Southern California's Lusk Center for Real Estate. "Some banks are being burned and their loans are not performing well. If you're a banker, you want your loan to perform and be repaid on schedule."

As a result, bankers have to think twice, thrice, and more before approving residential projects Downtown because the notion of urban living is still so new, Gabriel explains. "Banks will look at that as opposed to when they are investing in Westlake Village, for example, where household incomes and other trends are more certain."
Most experts, supported by industry insiders, opine that lender hesitancy may be partly due to a lack of education about and exposure to loft conversion projects and other opportunities for development in Downtown.

After all, the market is still relatively new, so many lack experience in the area. That can mean delay upon delay. For instance, Downtown loft developer Tom Gilmore, president of Gilmore Associates, is considered the pioneer of such development Downtown, a so-called Pied Piper for his conversion of old office buildings here. But his first building in the Old Bank District, the San Fernando, is just a year old.

"In other cities where the downtown has been on a roll for a longer period of time, the banks there get it," said Carol Schatz, president of the Central City Association and Downtown Center Business Improvement District. "I think our banking institutions need a little more encouragement. I think we have to figure out how to do that. We need to find out from the banks' perspectives what they need and develop that new criteria."

Michael Banner, the national inner-city advisor for the Urban Land Institute, said it boils down to leadership: No bank wants to be the first urban pioneer on the block.
"Lending money is not that complicated," said Banner, who is also the president and CEO of Los Angeles LDC Inc., a firm that works as an intermediary between lenders and developers. "Lenders want to know that a developer has a history of being successful. But when you're trying to be on the cutting edge, [like in Downtown], there is no history. It then becomes a leadership issue in terms of the developer or sponsor."

One positive sign, Banner notes, is that last week, Insurance Commisioner Harry Low sent out a letter to insurance companies asking them to commit to community lending and investment--something that will help developers plan for future projects.

Banner, whose firm worked on helping Gilmore obtain financing for the Old Bank District project, says a "triad" of private, public and community leadership is key to success in urban development. "Lenders want to see leadership that says, 'We believe this is a good project for the area.' They want commitment of some kind."
The process then becomes akin to "piecing together a quilt," says Banner, who also warns that the drawback to using public money is the administrative red tape attached. So much that when Bud Hawley, a partner in Oxford Street Properties, was looking for public money, he put together an entire team of experts from the lending side to help him find the best sources for tax credits.

Following Banner's model, developer Mark Weinstein, MJW Investment and a longtime developer, has managed to cobble together a blanket of support from the City Council, the Mayor's office, and the departments of Housing, Planning and Transportation, for his ambitious 600-unit residential and retail project located in the Fashion District. Called Santee Court, Weinstein hopes to begin construction next year.

Weinstein, like most developers, completed his financial package by tapping several sources: a major bank loan, secondary loans from city agencies, grants and other tax credit programs, and personal equity. The difference between the developers' equity and the loans is called the "gap," which is the trickiest part of the financing, since it requires creative solutions and more pounding the pavement in search of funding.

"Without City Council support, projects don't get done,"
Weinstein asserts. "Councilman Nick Pacheco is the head of the housing committee, and Santee Court is in his district. He, better than anyone, understands the need for housing here and the challenges."

While the city has yet to come up with its solution for filling the gap, the state's Downtown Rebound program served that purpose. But the California energy crisis cut the program for next year, eliminating one of the most crucial gap financing sources for developers. Now, they say, the challenge will be finding new ways to bridge the gap.

"We're in a big crunch and we're going to be behind the eight ball," warns Weinstein, who like other developers is hoping City Hall steps in to help. "We have to build no less than 8,000 units a year to meet the housing demand. The city needs to encourage us as developers to do as much as we can."

A new City Hall administration is giving developers some hope on that front. Mayor Jim Hahn has said he will make mixed-income and mixed-use development a priority, and "they seem to be serious about that," Weinstein praises. So far, Weinstein has received help from several fronts, including the mayor's new Business Team director Jonathan Kevles.

Weinstein says he also needs city help in resolving Downtown's lack of parking because it has become a factor among lenders now and the forseeable future. That's because all lenders that make major loans on apartments--the federal government, Fanni Mae, HUD, Bank of America, everyone except the City of L.A.--requires a parking component, he notes. For Downtown, the lenders require at least one space minimum per unit, whereas for other places in the city they require two. But even that one-to-one ratio is hard to come by.

"The issue is that lenders are hesitant to lend without some type of covenant, lease or ownership in parking. Public lots are not good enough. So now lenders are looking at what the city is doing, and if the city is not willing to invest, then the lender gets nervous. You have to work in conjunction," Weinstein explains.

Still, Gabriel underscored that so often in real estate, it boils down to the quality of an analysis in the loan application package. "If developers in specific cases make pursuasive arguements, it takes them quite some distance."
For example, as a veteran developer, Weinstein said he has been able to maneuver the nuances and pitfalls of urban developement far better than newcomers who often fall victim to the complicated and time consuming process of putting together a financing package. "If you are a strong developer, they look at your track record," Weinstein said. "I've been doing it 20 years with apartments and retail. They look at a developer, then the project."
But experts agree that there is also an evolution happening in the lending industry. Banks now are trying to understand their new role in community investment, making the leap from traditonal loans to understanding the challenges and opportunities of working on inner-city revitalization projects, Banner said. "One of the things driving that evolution is that other parts of their business is going away," he noted. "They are now looking for the best opportunities to invest their capital and their people.
"It's tough because the traditional forms of capital have rules and sometimes these downtown areas are on the edge of those rules," he added. "Often these projects are viewed as not being able to apply to the rules."

Banner noted that most developers simply want to know the rules. That will be the thrust of ULI's next conference in March, which will focus on mixed-use housing development. "As a lender, you must define what your role is. You can't hide behind the telephone forever."

Market research will aid lenders in this process and give developers an edge, he said, helping to clue lenders in to what's happening Downtown as a "good, profitable and safe thing." The more information, the beter the likelihood a project will get financial backing. "The more they understand what's going on the more they will understand who you are and what you're doing," Banner said. "They should be your advocate."

But the banks and other lenders say they know perfectly well what's going on. They're just picky, and that's precisely their job.

In addition to having already approved the Palmer Associates' two-phase Medici project, Komerica Bank's Delora says he's right now looking at a loft conversion project by the Simpson Group near Union Station. "We're into 30-to-40-year-old development companies that have proven their ability," he says matter of factly.

Fannie Mae, unlike the banks, has a different strategy dictated by federal law since it was chartered by Congress to promote affordable housing. That means Fannie Mae won't underwrite Medici, for example, but it will work on Gilmore's market-rate development in the Old Bank District. Fannie Mae's Zeidman acknowledges: "I don't think we've seen any discussion about quitting. We go where the market is. The market in Downtown L.A. is conversion."

Although lenders are not necessarily hesitant to lend in urban areas, the finance world has a long memory. Take for example, the Premiere Towers which had to be bailed out by the Community Redevelopment Agency. "Even now, 10-12 years later, people are pointing their fingers and saying, 'We told you so'," Zeidman emphasizes. "Downtown doesn't need failures. If a developer doesn't have 20-30 percent of their own equity at stake, we'll care about every nail."
As a result, lenders consider two factors when putting their money on the line: Will developers be able to keep the units occupied, and is already too much housing in the area.

For instance, Zeidman helped financed three of the four residential buildings for Gilmore's Old Bank District. When the last of his loft-style apartments are completed by the end of 2002, there may not be any more banker interest for other residential development there. "How much more can the area handle? That makes lenders cautious," she explains.
She says she and other lenders are waiting residential projects to be bolstered with Westside-like amenities: name supermarkets, more schools, supportive services.

"Every project can be made stronger in some way and can be done by a lender," she says. We will continue to invest as good sound projects come on the board. But people need to understand why financers look reluctant."

Reprinted with permission from Los Angeles Downtown News