Pan Am development deal dies

August 27, 2007

Fallout from the subprime mortgage fiasco has scuttled a developer's plans to acquire Pan Am Plaza and could complicate a host of other development deals under way in Indianapolis.

The dropped deal is the first sign that turmoil in the credit markets--sparked by stagnant home sales and defaults on nontraditional home loans--could take a toll on commercial transactions in Indianapolis. There's plenty at stake: Deals in the works include the redevelopment of the Market Square Arena site, the potential sale of First Indiana Plaza, and several mixed-use projects in their planning stages.

Houston-based Principle Equity Management had hoped to build a $50 million restaurant and retail development on Pan Am Plaza, its first local acquisition. But a lender scaled back its commitment two days before the company planned to close on its purchase of the office building and plaza from California-based Coastal Partners LLC.

"Coastal was gracious enough to give us an extension during this implosion of the capital markets, but it's going to take more than an extension to weather this storm," Dan Summers, Principle's managing director of acquisitions, told IBJ. "This is a national debacle; we got caught right in the middle of it."

Summers described the decision to pull out of the deal as "excruciating." He said the company's accountants still were tallying how much Principle would lose on the proposition.

"I would suspect any deal under contract that hasn't closed yet is affected," Summer said. "Not one borrower is insulated."

In recent weeks, concerns over credit have begun to moderate on Wall Street, as the Federal Reserve added liquidity to the market and cut the discount rate to 5.75 percent. Still, commercial lenders have become skittish, particularly with highly leveraged deals. They're demanding more equity.

"We're seeing a number of deals go sideways, or the lenders back out," said Robert Bach, vice president of research for Chicago-based Grubb and Ellis. "The terms are much less generous than they were just a few weeks ago. There really is a credit squeeze out there, and it is affecting commercial real estate."

Particularly vulnerable are commercial loans that lenders intend to package and sell as securities. These account for about 20 percent of all commercial real estate lending, and are used to buy completed properties. They are attracting some of the same skepticism as packaged home loans, said Bach, who has an office in Indianapolis.

Borrowing costs for these types of loans have risen as much as 2 percent in the last few weeks, and delinquencies were up more than 12 percent in the second quarter, according to a research report by Bethesda, Md.-based CoStar Group Inc.

New construction projects--such as redevelopment of the MSA site--are less likely to be affected, as banks still are competing for that business. Yet Bach expects lenders across the board will be more cautious, leading to a slowdown in commercial real estate transactions and cancellation of some announced projects.

He said dozens of pending deals across the country have been affected, ranging from a portfolio of research-and-development properties in Silicon Valley to an apartment real estate investment trust in Denver. The owners of a skyscraper for sale in Indianapolis, First Indiana Plaza, also could feel the impact.

"I would think lenders will be sharpening their pencils on all their commercial real estate deals going forward," Bach said.

On a local level, most projects backed up by sound fundamentals are still doable, said Gerry Kosene, managing partner of locally based Kosene & Kosene Residential Inc. Kosene and locally based Pedcor Cos. are one of two teams vying to redevelop the former home of Market Square Arena.

The Kosene-Pedcor group is pitching a $130 million residential and retail project with a 21-story tower north of Market Street and a 15-story tower south of Market Street. The other group--which includes Lauth, Mansur Real Estate Services Inc., Hearthview Residential Inc. and Venture Real Estate Services--wants to build a $150 million complex including offices, homes and a Target store.

"The cost of money is a little higher," Kosene said. "But if it's a good project, it should be financeable."

Factors that affect financing deals include market conditions, location of a project and the company's track record. Companies such as Duke Realty Corp. and Simon Property Group Inc. probably won't encounter more hurdles on financing, but smaller players might, Kosene said.

The squeeze won't stop a new JW Marriott convention headquarters hotel, but it might affect the developers' spreads, said Mike Wells, president of Indianapolis-based REI Investments, which is partnering on the project with Merrillville-based White Lodging. The 1,000-room hotel is part of a $250 million complex of hotels slated to open in January 2010.

The White-REI project is backed by loads of equity, including $48.5 million from the city, which separates it from other projects that are more "on the edge," Wells said.

"In the long run, I think it's a good thing for the real estate business," Wells said. "It is a flight back to quality. It eliminates some of the projects that shouldn't be done."

Financing deals will get more conservative, and some of the highly leveraged dealmakers will be shaken out of the market, said Dennis Dye, executive vice president of Indianapolis-based Browning Investments Inc. That could result in a "hiccup" in valuations since fewer potential buyers would be bidding on properties.

"After a settling-down period of a month or two, deals will start getting done again," Dye said. "But I don't think you'll be seeing people going after interest-only deals."

As for Principle and its Pan Am deal, the timing could not have been worse. It was not clear at press time whether the property would be put back on the market.

"I think they just got caught in this capital market vise," Dye said. "Those guys had every intention of getting a deal over the goal line."

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