Commercial real estate is reportedly in trouble. In February 2010, the Congressional Oversight Panel for TARP (Troubled Asset Relief Program) issued a report suggesting that half of the $1.4 trillion in short-term, commercial real estate loans coming due in the near future (2010–2014) were underwater. At hearings in February and March 2011 on the subject, Matthew Anderson of Foresight Analytics noted that the value of commercial real estate has declined by 42 percent since 2007. Richard Parkus of Morgan Stanley Research provided a graph showing that practically half of loans maturing each month since the onset of the financial crisis have been unable to find timely refinancing. Columbia University Professor and Nobel Laureate Joseph Stiglitz summarized, “Our economy is not back to health and will not be until and unless lending can be restored, especially to small- and medium-size enterprises.”
Commercial defaults, continued restrictions on commercial lending, and the related problems facing retail ventures in these neighborhoods will have profound implications for economic development projects.
Commercial Credit Squeeze
In a down economy, bankruptcies and vacancies can devastate a retail plaza or larger commercial development project. Meanwhile, financing for in-the-works economic development projects is being jeopardized as skittish banks change terms or pull out entirely. Private-sector entrepreneurs and real estate developers have been stunned as banks reduced prior commitments or revised long-term relationships despite positive track records by successful borrowers.
Even government guarantees and subsidies haven’t been enough to bring the big banks back into the game. Wisconsin’s Housing and Economic Development Authority (WHEDA), for example, is an independent authority created by the Wisconsin legislature with over $3 billion in assets. In addition to its affordable housing financing, WHEDA provides capital for economic development through its small business guarantee and related programs. WHEDA regularly furnishes 80 percent loan guarantees and enhances projects with subordinated debt, a percentage of which (often 10 percent) frequently can be converted to equity or forgiven entirely. And yet, WHEDA’s participation doesn’t generally bring financing down to the 60 percent loan-to-value level that national banks have been demanding.
As a result, says WHEDA’s director of economic development, Farshad Maltes, national banks have disappeared from the authority’s deals in recent years. With the exception of U.S. Bank’s CDC, which has been an active purchaser of New Market Tax Credits in Wisconsin, the financial institutions participating in WHEDA-funded projects are primarily local community banks.
If major banks are less active even when loan guarantees and similar credit enhancements are available, recovery in lower-income communities will be considerably slower than in other segments of the economy. Despite the pressure generated by the Dodd-Frank financial reform legislation and nationwide efforts by advocacy organizations such as the National Community Reinvestment Coalition, many national lenders are apprehensive about being considered by regulators to have unhealthy concentrations of risky commercial real estate loans in their portfolio. Replicating the WHEDA approach might allow more community banks to step into that space and participate in larger real estate deals.
WHEDA also routinely refers entrepreneurial endeavors to local CDCs. CDCs and CDFIs have long played critical roles in targeting capital for commercial projects to underserved commercial areas, but now many CDCs and CDFIs have found themselves called upon to step into a wider range of deals to keep important economic development projects on track.
When Industrial Glass Products, Inc., a minority- and woman-owned specialty glass manufacturer that has operated since 1991 in a Los Angeles neighborhood with 98 percent minority population, observed most of its competitors west of the Mississippi closing their operations, it sought financing to expand. Finding few banks willing to provide additional capital, it turned to TELACU Community Capital (TCC), a CDFI subsidiary of The East Los Angeles Community Union, one of the nation’s largest CDCs. TCC provided a loan for working capital and real estate refinancing. The additional investment capital for machinery, equipment, marketing, and improved production schedules, allowed IGP to pursue customers previously served by competitors. As a CDC with years of experience in development, financing, and government contracting, TELACU understood the subtleties of supporting a company capable of growing jobs while working with a customer base of aerospace and other global firms.
In Milwaukee, a prominent CDC obtained a federal grant from HHS/OCS for a green business converting recycled newspapers into cellulose fiber insulation. The supported entrepreneur had operated a comparable but unrelated business with his brothers less than a mile away. He was the owner of a partially improved manufacturing plant worth over $4 million that he was offering as collateral for a renovation and working capital loan to begin production of insulation materials. Despite an 80 percent governmental loan guarantee and a substantial real estate asset, the deal was initially jeopardized as the original bank demanded that the entrepreneur deposit a supplemental $1.67 million collateralizing amount to secure a $1.67 million loan. The sponsoring CDC in Milwaukee contacted the rural CDC/CDFI Impact Seven in western Wisconsin, which agreed to step in and preliminarily rescue the deal.
Impact Seven has collaborated with other CDCs, supportive state agencies, and developers to rescue a number of other projects that found themselves in jeopardy during the credit squeeze. One such project involved a conversion of a vacant industrial warehouse virtually adjacent to the Harley-Davidson Museum in Milwaukee into a boutique hotel targeting motorcycle enthusiasts and business travelers. Impact Seven’s $800,000 in gap financing allowed the project to move forward. Located in a neighborhood across the river from downtown with a significant Hispanic population and that had historically suffered from underinvestment, the popular hotel, The Iron Horse, now employs over 65 people.
CDFIs like Impact Seven are also serving as loan brokers for smaller financial institutions. In one instance, a bank making an SBA 504 loan was unable to find other conventional financial institutions to participate in the loan package for the construction of a 36,000 square foot machine shop, which was creating 25 to 30 new jobs in Waupaca, Wisconsin. Impact Seven not only participated in the interim and permanent loans for the project, but also played a key role in packaging the deal for SBA 504 financing. This was possible because the Obama administration has expanded the SBA 504 program to both provide refinancing for small business, owner-occupied commercial real estate and permit participation for the first time by CDFIs like Impact Seven.
Neighborhood-based institutions can be much more than just another source of capital for entrepreneurs functioning in a time of tight credit and declining property values. In Philadelphia, another prominent CDC, Impact Services, combined its financing role with its community organizing skills to support the retail tenants of a new shopping plaza in an industrial area bordered by extensive low-income housing mixed in with pockets of market-rate residential structures. It organized merchants, local police, bankers, and local residents to form a business improvement district. Volunteers hung marketing banners on old, overhead rail trestles. CDC staff and merchants undertook a range of cleanup and other cooperative efforts, such as developing a “calling tree” when one of the merchants encountered credit card scammers.
With unemployment rates expected to be daunting as the recovery proceeds at a deliberate pace, capitalizing small, neighborhood businesses and reducing commercial defaults will be critical to job growth in areas of high unemployment. As federal dollars for economic development continue to be cut, more and more states and localities will be increasingly dependent upon leveraging private sector capital to foster local business growth and economic development innovations.
Unfortunately, less-than-flexible reviews of bank underwriting approaches taken by some federal regulatory agencies mean that federal policy enforcement personnel may continue to be uncomfortable with deals structured by models like WHEDA, the Massachusetts Community Development Finance Corporation, and others designed to catalyze additional private sector financing. Advocates should increase their voice in Washington and at the state level to support the use of recycled TARP dollars (which may no longer be available after September) to encourage states to create innovative finance programs.
Supporting the ability of CDCs to retain a mature staff that understands the nuances of development and entrepreneurship will be essential for allowing them to continue bridging these gaps, addressing unemployment, keeping commercial spaces occupied, and helping restore local economies. The funding for such quality personnel was a key part of the original Title VII CDC Program that was nurtured legislatively by bipartisan efforts of the late senators Jacob Javits and Bobby Kennedy. However, in light of new funding constraints at the federal and philanthropic level, the ability of CDCs to function as they did in the past with respect to economic development and finance is uncertain. Given the enhanced role CDCs have been playing, if foundation and federal funding for CDCs diminishes substantially, it may dramatically exacerbate the credit crunch for small business.