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Flood of foreclosures expected to put more property underwater

By Evelyn Lee

As the recession creates record-high vacancies in New Jersey’s commercial real estate market, more buildings are going back to lenders, and some industry insiders expect the number of distressed assets to increase, as more mortgages are due to mature during the later half of this year and 2011.

In New Jersey, 177 commercial real estate assets, totaling $6.53 billion, were in distress as of Aug. 16; commercial distress situations include lenders taking back properties via foreclosure and troubled mortgages, according to Real Capital Analytics, a New York-based market research firm that tracks assets valued at $2.5 million or more. At the end of June 2009, 93 properties, totaling $3.97 billion, were in distress.

Real estate distress “demonstrates today’s economic difficulties,” said David Simson, vice chairman and chief operating officer of the New Jersey operations of commercial real estate services firm Newmark Knight Frank.

During the second quarter, the office availability rate in the Garden State hit a record high, rising to 25 percent, from 23.6 percent a year ago, while industrial availability remained at its historical high of 17.8 percent, according to Newmark Knight Frank.

“There’s an under-demand for space; there’s not a lot of organic growth of the existing tenant base,” Simson said. “There’s been quite a lot of downsizing and, in certain situations, relocations out of state.”

Simson’s firm brokered two REO, or real estate owned, sales — 290 Davidson Ave., in the Somerset section of Franklin Township, and 2000 Cornwall Road, in South Brunswick — during the second quarter. REO refers to property owned by a lender as a result of foreclosure.

Tenants vacating space has been the nail in the coffin for many commercial real estate assets. For example, 290 Davidson Ave. and 2000 Cornwall Rd., both foreclosures, are unoccupied after losing their tenants — AT&T and Pharmacopeia, respectively — over the past two years.

Falling property values has been another factor: Of the 26 securitized loans in New Jersey reappraised during the first half of this year, 20 are underwater, according to Trepp LLC, a New York-based commercial mortgage-backed securities and commercial mortgage information provider.

A lender may extend the loan if the property is likely to be leased in the near future, said Ben Thypin, senior market analyst at Real Capital Analytics, but in many cases, the lender is forced to take back the property and sell it to a third party, or operate the building until the market improves, he said.

Simson said he expected eight to 10 more office buildings of more than 75,000 square feet to be put on the market during the second half of this year. “In the event that we do not see growth in employment and companies start to expand, this will be the trend through 2011,” he said, expecting more sales of troubled New Jersey assets to occur in 2010 and 2011 than at any point over the past decade.

According to the state Judiciary, 754 commercial real estate foreclosures were filed in the Garden State during the first half of 2010, compared to 767 during the same period a year ago.

“A lot of those loans that are maturing in the next couple of years, they’ve already gotten in trouble,” Thypin said. Borrowers may have been unable to make monthly payments or meet certain covenants under the loan terms, such as the property generating a certain amount of income.

With a growing number of buildings in foreclosure, “there’s a fair amount of potential cost-setting in the future that could transpire,” Simson said.

If the lender sells an asset at a discount to a buyer, the new owner can rent the property for a lower rent than a competing building, he said, which can “create a more competitive field.”

But buyers of distressed properties need to be careful not to fall victim to distress themselves, said Mukesh M. Patel, a managing director at NextBridge Group, which acquired 220 Davidson Ave., in Somerset, in June. “There are good opportunities to find value-added deals in this marketplace, but you have to approach them cautiously.”

According to the township tax assessor’s office, the Somerset-based private equity fund manager paid $5.275 million for the building, which had been returned to the lender by its previous owner. The asset last traded in 2004 at $16 million, and was assessed in 2009 at $22 million.

But “simply buying it cheap is not necessarily buying it at value,” said Manish C. Shah, also a NextBridge managing director. The firm had looked at other properties where “you would have to get paid to take the asset, because of existing operating costs, deferred maintenance and the challenge of leasing it.”

To tackle the challenge of leasing 220 Davidson Ave. — slightly below the market occupancy of 75 percent — the firm is investing in capital improvements, including a resurfaced parking lot, a renovated lobby and free Wi-Fi in the common areas.

The previous owner of 220 Davidson Ave. bought it at a price where he thought he would be able to make money on the property, but failed to do so, Shah said.

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