Tilting Toward Slowdown.


The pendulum is swinging decisively toward a real estate market slowdown. Originations are down substantially, developers have become more cautious and rates look like they are headed up further. We polled market participants to see how they rate real estate's prospects in the months ahead.

It's official. THERE IS A SLOWDOWN UNDER WAY IN SOME PARTS of the real estate development industry, and especially in the number of mortgage loan originations--although nowhere near as pronounced as the one 10 years ago.

On a scale of one to five, with five being the peak of the cycle, most lenders contacted for this story say that, if the market has not already hit its peak, it is pretty close; one even rated the market at five. So while the real estate market may be going full tilt in a lot of places, the signs are everywhere that it could start heading downward soon.

One thing is for sure: The refinancing market is way off, the result of a rise in interest rates as well as the fact that many borrowers refinanced early when rates were low. In late May, more interest rate hikes appeared to be in the offing.

David Durning, Chicago-based managing director for Prudential Mortgage Capital Company, pegs the real estate cycle at a rating of at least four and possibly five. Durning, who is head of originations for Prudential Mortgage Capital but is primarily focused on the Midwest, says the major markets in the Midwest have now fully recovered from the real estate debacle of the early 1990s. He doesn't see any problems yet, although the number of loans is down this year as compared to last, which may be a harbinger of things to come.

Harvey E. Green, president and chief operating officer of Marcus & Millichap, Encino, California, says, "We are at a three and a half, possibly at four [in the cycle]. It all depends on interest rates hikes. If we see a real cooling, we could slide toward a recession."

Green sees contradictions in today's real estate climate. "I do believe the obvious--that any time interest rates kick up, it does affect the NOI [net operating income]," he says. "But the economy is so strong and household formation is still so strong that rents are increasing [in most markets]."

Richard Coe, managing director for development, investment and capital markets at Dallas-based Trammel Crow Company, says, "In general, development activity has slowed in all kinds of product, with the exception of Southern California, the San Francisco Bay Area, Seattle and the Northeast to the Mid-Atlantic. But in Atlanta, Dallas, Chicago, Denver and Phoenix, there has been a significant slowdown. The reason for this is that there has been a lot of development in the last three to five years, and that product has been absorbed."

Coe credits the relative tranquility in the real estate market to the fact that public markets, such as real estate investment trusts (REITs), influence how money is doled out to developers. As a result, he says, funds are not available today unless there is a market for the real estate. The upshot of this new discipline is that the real estate market is fundamentally in equilibrium, according to Coe, even though a slowdown is occurring.

If he had to rate where the real estate market is in the cycle, David Goodman, president of Columbus, Ohio--based Banc One Capital Funding, says, "We're between three and three and a half. Interest rates are up and debt-service constants are as high or higher than cap rates. That means that developers have to put more equity into a deal. When interest rates are lower, they have positive leverage from their debt."

Yet, in spite of higher rates, says Goodman, "We've got about 30 percent more new construction deals in our pipeline than we did last year." He credits this good fortune to the fact that Banc One is not doing only conventional mortgages, but acts as an investment banker as well.

E.J. Burke, senior vice president of Key Commercial Mortgage, Kansas City, says the real estate market is at about a four today. "Our loan volumes, compared to last year, are holding steady," he says. "We're actually on top or ahead of last year, but there is no question that the market has slowed...

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