Michael Epstein thinks the Three Ponds Business Park he and his partners bought June 30 for $7.2 million in Columbia was a steal. Richard Alter, president of Manekin Corp., which owns competing buildings in the same corporate campus, is afraid Mr. Epstein is right.
"We're buying buildings for about 40 percent of their [construction] costs, said Mr. Epstein, a partner in BECO Management of Herndon, Va. "That lets us make a return on our investment at much lower rents than people who have to pay back loans based on construction costs."
Deals such as Mr. Epstein's are unusual for now, but they won't be for long. Banks and other lenders -- insurance companies, for example -- own about 10 percent of the office space in metropolitan Baltimore. They have sold only a small chunk of what they own. BECO bought Three Ponds from MNC Financial Inc., which has plenty of repossessed buildings in its portfolio.
But when the lenders sell, properties such as Three Ponds are getting dumped at a fraction of what they cost to build.
No one building is going to shake up the whole market, no matter how cheaply its lender sells it. But put them all together, sell them all for 40 cents on the dollar, and you have the commercial real estate business' latest gorilla-sized headache.
The question: Is this gorilla a harmless stuffed toy, or the 'N 600-pound variety that throws around anyone in its way?
"I'm not happy about it," Mr. Alter said. "I can't give you a definitive answer. It doesn't do me any good."
"What you're looking at is sort of the domino effect," said Tom Burns, a broker for the Carey Winston Co. in Laurel. "We'll see additional buildings going back to the banks [because of tougher competition from resold buildings]. It's going to allow the new owners to do leases substantially below what competitors need to cover the payments on their debt. They're going to have to renegotiate their loans or they're going to lose tenants."
That's the disaster scenario, and it doesn't come entirely out of left field. New building owners like Mr. Epstein and Ray Turchi, a partner in the group that bought the downtown Redwood Tower from a California bank last month, say candidly that they plan to play their price advantage so hard that competitors can't keep up.
"All we're doing is passing along our savings to the tenant," Mr. Epstein said. "If [competitors] come down to our price, it's a question of how much they're going to lose and and whether they'll continue to own the building."
That can cause problems in two ways, the worriers say. Obviously, a developer who has to cover a $4 million mortgage can offer tenants terms that a competitor down the street with a $10 million mortgage can't. The low-cost owner may even be able to steal tenants when their leases expire, or buy out the remainder of their leases at other buildings, taking income away from so-far-solvent developers.
The subtler, but possibly more serious, problem is that many office buildings are financed with "bullet loans." Those loans run for five or seven years and then have to be replaced by new loans when they come due.
But one thing lenders look at in making loans is the recent sales prices of comparable buildings nearby. If those are trading for 40 cents on the dollar, banks may not be willing to refinance developers' whole mortgages.
Mr. Epstein proposes a scenario that runs like this: A solvent developer who has a $20 million mortgage might see a bank sell a repossessed building down the street to an organization such as BECO for $12 million. Then the solvent developer's bank might tell him, "Hey, the building down the road went for $12 million; we can only refinance you for $10 million. After this recession, that's all your building is worth."
That way, even developers who have survived this far in the recession could get squeezed anew, unless they have a spare $10 million lying around. Or so the scenario goes. But banks have resold so few properties -- and started selling so recently -- that no one knows how the trend will affect the owners of nearby buildings who have thus far managed to keep their heads above water.
"The neighbor, when his loan is due and he has an appraisal, the banks are going to use the most recent comps," said Mr. Burns, using real estate slang for sales of comparable properties. "Projects that were joint ventures with large institutions will be OK. It's the smaller owners who are going to have problems."
But many people in the business don't buy the doomsday scenario. Their argument boils down to this: No matter how the last few years made them look, bankers aren't fools.
"People's lenders are aware of the market," said Andrew J. A. Chriss, a vice president and broker in Manekin Corp.'s downtown office. He said banks will work with solvent developers, letting them cut prices to compete with the recycled buildings and making the best of a bad situation rather than force a second wave of office-building foreclosures.