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Next crunch?

Commercial real estate has battled the nationwide credit crunch better than other industries, but that could be coming to an end.

Mall owner General Growth Properties announced this week that debt problems could force it to sell assets or even the whole company. Analysts said the decision highlights a growing problem in commercial real estate as Wall Street turmoil seeps into markets across the country.

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Some commercial property owners are finding themselves in the same situation as many homeowners. As credit has dried up and sales of commercial real estate have slowed, property values have fallen - about 20 percent since the start of the credit crunch in early 2007.

That's threatening to leave some commercial owners owing more than their property is worth. At the same time, a pullback in consumer spending is pinching the businesses that lease offices, warehouses and shops. Vacancies are rising.

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That could mean more empty storefronts in neighborhood shopping centers and malls as well as added difficulty in filling vacant office space, analysts said.

"We're basically in a free fall," said David M. Fick, a managing director of Stifel Nicolaus & Co. in Baltimore. "A recovery could take years because the banking system is in rigor mortis."

Even Fed Chairman Ben S. Bernanke warned in testimony to Congress yesterday that "financing for commercial real estate projects has ... tightened very significantly."

"As of midyear, business investment was holding up reasonably well, with investment in nonresidential structures particularly robust," he said. "However, a range of factors, including weakening fundamentals and constraints on credit, are likely to result in a considerable slowdown in the construction of commercial and office buildings in coming quarters."

The good news is the Baltimore region is better positioned than it was when the last real estate boom turned to bust during the late 1980s and early 1990s. One difference between then and now is that - despite higher vacancy rates locally - "commercial real estate is not nearly as overbuilt as it was at the end of the '80s," said Joseph M. Cronyn, a partner with Lipman Frizzell & Mitchell, a real estate consulting firm in Columbia. "That was a vast overhang."

Still, experts say current trends are likely to accelerate now that the credit crisis has moved beyond lenders to infect companies as varied as investment banks, a major insurer and Baltimore's Constellation Energy Group. The past two weeks brought the bankruptcy of Lehman Brothers Holdings Inc., the bailout of insurer American International Group Inc. and a buyout of Merrill Lynch & Co.

Even before the most recent turmoil, Baltimore-area commercial developers showed signs of pulling back or just waiting out a market that has scared off residential buyers and curtailed expansion plans for businesses and retailers that lease space.

The number of new projects offered for review to Baltimore City planners, for instance, has slowed in the past few months. Several proposed towers around the Inner Harbor with a mix of housing, shops, offices and hotels are on hold or being redesigned. A developer of a downtown Baltimore revitalization project known as the "superblock" has reacted to changing market conditions by scaling back the number of apartments and shops.

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Some experts fear commercial real estate could be hit harder during the next 18 months, as a huge amount of debt comes due and refinancing stays tight.

General Growth's troubles could be an indicator of more to come from other real estate companies. But GGP's debt levels are also much higher than those of its biggest competitors, Fick said, stemming from when the company acquired the Columbia-based Rouse Co. nearly four years ago for $12.6 billion.

"Assets that could typically get refinanced, including major malls in Baltimore ... have mortgages coming due with [high] loan-to-value ratios, and there's no money available at any reasonable price," Fick said.

General Growth, which owns most of the regional malls in the Baltimore area and is the master developer of Columbia, announced Monday that it might need to sell assets or equity to raise capital and that it will also consider "strategic business combinations" to boost its stock. The company owns White Marsh Mall, Owings Mills Mall, Towson Town Center, The Mall in Columbia, the Village of Cross Keys and Mondawmin Mall. It also owns Harborplace & The Gallery in downtown Baltimore.

It's unclear whether any Baltimore-area malls could be sold, and General Growth officials had no comment. Officials did begin shopping Cross Keys earlier this year.

Baltimore already has seen its share of stalled development projects, thanks to the faltering economy and nationwide housing slump. As of April, more than $1 billion in development projects - offices, residences, stores and hotels that would change Baltimore's skyline and help to revitalize the city - had been recast or were in limbo, waiting out the market.

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This week, Lexington Square Partners, one of the west-side "superblock" developers, said it plans to scale back retail space by half - to 150,000 square feet - because interest from a "big box" retailer has waned. The number of apartments is being trimmed from about 400 to 350, said Bailey Pope, vice president of design and construction at developer Harold A. Dawson Co. Inc., a Lexington Square partner.

Investors in commercial real estate have begun to scrutinize tenants more closely to determine the likelihood of lease renewals.

"They're all being given a great deal more attention to determine how healthy they are," said Philip Iglehart, a managing director of Colliers Pinkard Capital Markets Group in Baltimore.

Jim Caronna, a principal at commercial real estate services company NAI KLNB, said privately held commercial developers in the area don't seem to be feeling the pressure hitting such companies as General Growth. He hasn't heard of developers being cut off from financing, for instance.

"It may be a little bit more difficult to get financing than it typically has been, but other than that inconvenience ... I think it's [as] 'business as usual' as it can be under these circumstances."

But more trouble could unfold during the next 18 months, some predict.

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"There are a lot of loans that were done over the last 10 years that are going to be maturing, and there may not be a place to refinance them," said David P. Scheffenacker Jr., president and chief executive of commercial real estate services firm Preston Partners Inc. "The same banks that lend or did subprime loans are also in the commercial real estate lending business, so if the banks are pulling back on one type of real estate because of devaluation, it also affects other real estate that they lend to."

Cronyn said tightening credit is "a growing problem."

"The core of owning real estate is leverage, and therefore it's very important that credit be available and it be reasonably priced, both of which are problems right now," he said.

But employers are still adding jobs in the state, which helps, he said. And some parts of the Baltimore region - particularly Harford and Anne Arundel counties - can expect office demand related to the national military base realignment and closures.

"In our market, the real estate is pretty resilient and holds values pretty well," Scheffenacker said. "We'll fare better than most submarkets in the country."

It is tougher for developers to borrow, said Owen Rouse, director of capital markets for Manekin LLC, a commercial developer based in Columbia. But banks haven't stopped lending, he said.

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"We've got a stable of local banks that have been alongside of us on our projects," Rouse said. "We haven't had to go to the credit window to see about new financings very much."

Some local developers see opportunity looming as economic problems increase. St. John Properties in Woodlawn, which is breaking ground on four Baltimore-area projects this fall and next spring, is gearing up to buy in the coming months as strapped companies sell or banks eliminate real estate.

"We are not having a credit crunch," said Jerry Wit, St. John's senior vice president. "We've amassed a large amount of money looking to take advantage of something that might come available, either real estate or an operating company with heavy real estate."


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